CIHM 
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Series 
(Monographs) 


ICMH 

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microfiches 
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Canadian  Institute  for  Historical  Microredroductions/lnstitut  Canadian  de  microreproductions  historiques 


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V 


Additional  comments  /     Pagination  is  as  folloHs:   [3]-xv111,   [ll-551. 

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Ca  doeumant  ast  fi|m4  au  taux  d«  r#duetion  indiqu4  ci-deasous. 


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30x 

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d'impression  ou  d'illustration  et  en  terminant  par 
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empreinte. 

Un  des  symboles  suivants  apparaltra  sur  la 
derniire  imege  de  cheque  microfiche,  selon  le 
cas:  le  symbole  -♦•  signifie  "A  SUIVRE".  le 
symbols  V  signifie  "FIN  ". 

Les  cartes,  pisnches,  tableaux,  etc.,  peuvent  itre 
filmis  A  des  taux  de  reduction  diffirents. 
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Modern  Business 

CANADIAN  EDITION 

A  SERIES  OF  EIGHTEEN  TEXTS,  ESPECIALLY  PREPARED 

FOR  THE  ALEXANDER  HAMILTON  INSTITUTE  COURSE  IN 

ACCOUNTS,  FINANCE  AND  MANAGEMENT 


EDITED  BT 

JOSEPH  FRENCH  JOHNSON 

DBAM,  raw  Toax  nfivBRSiTT  SCHOOL  or  comnacs,  Accomrn  ako  miANCB 

raw  TOKK  OITV 

Title  Author 

APPLIED  ECONOMICS Jambb  Mavob 

ORGANIZATION  AND  MANAGEMENT  Lee  Gaixowat 

SELLING R.  S.  Butusb 

CREDITS Lee  Gallowat 

TRAFFIC S.  J.  McLean 

ADVERTISING Lee  Gaixowat 

BUSINESS  CORRESPONDENCE   .     .  G.  B.  Hotchkiss 

ACCOUNTING  PRACTICE  .     .     .     .  (Jbo  Gmsendlingbb 

IE.  W.  Wbight 

CORPORATION  FINANCE  .     .     .     .(!I^"^1_^"™ 

V  Fbed  W.  Field 

MONEY  AND  BANKING    ....  {  ^  "w^S^^^iT"" 
BANKING  PRACTICE E.  L.  Stewabt  Pattbbbon 

FOREIGN  EXCHANGE (^TSf  ^^" 

V  E.  L.  Stewart  Patterson 

rTnouAB  Conwat 
INVESTMENT  AND  SPECULATION  .  |  Albert  Atwood 

I  Fred  W.  Field 

INroHANCE {CT*F^"' 

J^^A^ {^TVX"" 

AUDITINQ Sbtiiocb  Wamon 

COST  ACCOUNTS Stephen  W.  Giuian 

COMMERCIAL  LAW Walteb  S.  Johnbon 


Corporation 
Finance 


AN  EXPOSITION  OF  THE  PRINCIPLES 
AND  METHODS  GOVERNING  THE  PRO- 
MOTION.  ORGANIZATION  AND  MANAGE- 
MENT   OF    MODERN     CORPORATIONS 


BY 
WILUAM  H.  LOUGH 

VICE-PRESIDENT.  ALEXANDER  HAMILTON  INSTITUTE:  FOR- 
MERLY PROFESSOR  OF  FINANCE  IN  NEW  YORK  UNIVERSITY 
SCHOOL      OF      COMMERCE.      ACCOUNTS      AND      FINANCE 


IN  COLLABORATION  WITH 

FRED  W.  FIELD 

EDITOR  OF  THE  "MONETARY  TIMES,"  CANADA 


Modern    Business 

Canadian  Edition 

Volume  VI 


ALEXANDER  HAMILTON  iNSmUTE 
NEW  YORK 


r?   -^  -' 


-7 


AWXANDER  HAMILTON  INSTlTOTK 

.,_  CofTBioar,  1812  gy 

ALEXANDER  HAMILTON  INSTITUTE 

ALEXANDER  HAMILTON   INSTITUTE 

ALEXANDER  HAMILTON  INSTITUTE 


TABLE  OF  CONTENTS 


INTRODUCTION. 


CHAPTER  I. 

THE  CORPORATE  FORM. 

aacnoN  „o, 

1.  "Non-Stock"   Corporations 1 

2.  "  Stock "  Corporations I 

3.  Definitions 2 

4.  The  Fiction  of  "  Corporate  Entity  " 3 

5.  Corporations  in  Aiicient  Nations 4 

6.  Popularity  in  Modern  Times 5 

7.  Adaptability  to  Raising  Large  Amounts  of  Capitnl   .      .  5 

8.  Permanence 8 

9.  Centralization  of  Control 9 

10.  Transferability  of  Ownership i      .      .  10 

11.  Limited    Liability 11 

IS.     Disadvantages  of  the  Corporate  Form is 


CHAPtfeR  II. 
LEGAL  STATUS  OF  THE  CORPORATIONi 

IS.  Defining  and  Controlling  Ihstmments l*f 

14.  Common  Law  of  Corpohitions  .      .      .      .      ^      ;      i      .  17 

15.  The  State  Constitution 18 

16.  Method  of  Creating  the  Corporation 19 

17-  Essential  Features  of  the  Charter 20 

18.  A  Sample  Charter 22 

19.  The  Corporate  Naihe 24 

20.  The   Corporate   Purposes 24 

21.  Other  Imt>ortant  Fe^turei  oJf  the  Charter 28 

22.  The   By-Laws 28 

28.  Essential  Features  of  the  By-LAws B8 


via 

CONTENTS 

CHAPTER  III. 
8ECT.o«  INTERIOR  ORGANIZATION. 

24.  Rights  of  Stockholders  f*"" 

25.  The  Proxy  and  its  Uses *'' 

26.  The  Right  to  Dividends »» 

27.  The  Right  to  Information *^ 

28.  Liabilities  of  Stockholders                *^ 

S9.     Rights  of  Creditors                         •      •      .      .          ...  48 

SO.     "Dummy"   Directors               ** 

S2.     The  Efficiency  of  Corporate  Organisation   .      .'      .'      .'      ;  l^ 


8S. 

34. 

35. 

36. 

37. 

38. 

39. 

40. 

41. 
42. 
43. 
44. 


CHAPTER  IV. 

WHERE  AND  HOW  TO  INCORPORATE. 

A  Corporation  May  be  Chartered  in  Any  State  and  Do 
Busmess  in  Other  States  ° 

The  Regulation  of  "Foreign"  Corporations     .'      '      '      *      T, 
Choosmg  the  State  of  Incorporation      .                   '      '  ' 

Comparative  Charges  in  Several  States ?f 

Liberality  of  Corporation  Laws  in  Several  States    '      '  ,, 

Permanence  of  the  Laws  *      '     ^^ 

Reputation  of  Va... us  States ^® 

tages  of  the  Important  States  of  Incorporation  « 

The  Wide  Range  of  Choice  in  Incorporation   ..''«! 
Canada's  Corporation  Laws  •      •      •      .     64 

Extra-provincial  Licensing  Acts     .*      .'     .*     .'     .*     .'      '     ^'' 


.V 


CHAPTER  V 
CORPORATE  STOCK. 

45.  Stock  Certificates  Not  Fully  Negotiable     .      . 

46.  Par  vs.  Market  Value  of  Stock  •      •      •      .     73 

47.  Nature  of  Preferred  Stock  ^® 

79 


CONTENTS  VL 

SECTION  '*" 

48.     Uses  of  Preferred  Stock 81 

sy.     Cumulative  Voting ** 

jU.     Voting  Trusts ** 

51.  History  of  a  Large  Canadian  Holding  Company  ...  86 

CHAPTER  VI. 
TYPES  OF  BUSINESS  CORPORATIONS. 

52.  Further  Classification  of  Corporations M 

53.  The  "Parent"  Company »* 

54.  Nature  of  a  Holding  Company 95 

55.  The    Holding   Company    as   a    Means   of   Organising 

"Trusts"         9^ 

56.  Complexity  of  Holding  Companies 100 

57.  Organisation  of  the  Standard  Oil  Company     ...  101 


58. 

59 

60. 

61. 

62. 

68. 

64. 

65. 

66. 

67. 

68. 


CHAPTER  VII. 
THE  SOURCES  OF  CORPORATE  FUNDS. 

Summary  of  Preceding  Chapters 10* 

Four  Sources  of  Corporate  Funds 105 

The  Investing  Public  as  a  Source  of  Funds     .      .      .  107 
Difi'erence  Between  Investment  and  Speculation     .      .108 

The  Speculative  Public  as  a  Source  of  Funds     .      .      .  109 

Desirability   of   Borrowing   Funds HO 

Distribution  of  Security  Issues H^ 

Corporation  Growth  and  Bank  Loans  in  Canada     .      .  118 

Attitude  of  Canadian  Bankers 119 

How  the  Canadian   Bank   Makes   Loans  to  Corpora- 
tions       *** 

Bank  Loans  and  Credits 128 


CHAPTER  VIII. 
SHORT-TIME  LOANS. 


69.  Trade  Credit  as  a  Source  of  Funds     .... 

70.  What  Reliance  Should  be  Placed  on  Bank  Loans? 


125 

127 


y 


*  CONTENTS 

MCTION 

71.  Notes  Sold  th^  Public  a,  a  Source  of  Fnnd.  ^ 

72.  Canada's  Short-term  Loans  •      •      •     184 

73.  Canadian  Railway  Loans  ^** 

74.  Three-year  Land   Notes *** 

75.  Problems  of  Short-term  Loans ^" 

144 

CHAPtER  IX. 
THi:  C0R1>0RATE  MORTGAGE, 
re.     What  Determines  the  Value  of  Fixed  Assets^ 
77.     Nature  of  a  Mortgage  Bond     /'"'^  ^"^t'-'     •      •      .      147 

79      rr"!:"' ?''''*"^' °' '^  ^'^^'^  «^  Trust     [      '      '      '      '     !?' 
79.     Classlfic-Uon  of  Mortgage  Deed,  of  Trust     '      *      '      *       J' 

CHAPTER  X. 
TYPES  OF  CORPORATION  BONDS. 

80.  Classification    of   Bonds 

81.  Mortgage  Bonds  "« 

S2.     Sinking   Fund    Bonds ^*r 

88.     Collateral  Trust  Bonds "« 

84.     Equipment  Trust  Bonds .161 

B5.     Five-year  Equipment  for  Canadian  Railway;     .'     :     .'     ^ 

CHAPTER  XI. 
-nrPES  OP  CORPORATION  BONDS  (conttn.^^ 
88.     Debenture  Bonds     .... 

87.  Income  Bonds     . '71 

88.  Other   Types  of   Bonds     .* "* 

89.  Purposes,  Manner  of  Pavment    »\>A  r    "j...*      '      *      '      '^7 

demption  of  Bonds  '  ^""'*'"°"'  °^  '**^- 

»0.     Convertible  Bonds  ^^9 

181 

CHAPTER  XII. 
CORPORATE  PROMOTION-THE  NEW  ENTERPRISE. 
91.     The  Function  of  a  Promoter 

98.     "Discoverr  of .  Proposition         *•* 

188 


COKTlENTS  xl 

turn 

SECTION  .  -w 

93.  "Assembling"  a  Prdposition *»7 

94.  Financing  a  Proposition — The  Initial  Development  188 

95.  Foresight  in  Providing  Funds 1^ 

96.  Advantages  of  a  Wide  Distribntioii  of  Stdck     .     .     .  191 

97.  "Starting  Right"  in  the  Sale  of  Stock J91 

98.  A  Ckjncrete  Illustration *"* 


99. 

ioo. 

Ibl. 
102. 
lOS. 
104. 

105. 
106. 
107. 


JHAPTER  XIIi: 

THE  PROMOTER  AND  THE  CORPORATION. 

Professional  Promoters *^ 

Lawyers  and  Bankers  as  Promoters     .      .     •     .  *•  1^ 

Engineering  Firms  as  Promoters 1*9 

Secret  Profite  are  Illegal *01 

Misleading  Statemento  Constitute  Fraud     •      .      •     •  «0* 
Contracts  on  Behalf  of  the  Corporation  and  Their  Ac- 
ceptance   

The  Promoter's  Pay *0* 

The  Promoter's  Riiks  and  Labors 808 

Ii  the  Promoter  Over-Paid? «<>• 


CHAPTER  XIV. 
CORPORATE  PROMOTION— FORMING  CONSOLIDATIONS. 

108.  The  Importance  of  Small  Industrial  Combinations     .  810 

109.  Difficulties  in  the  Promoter's  Task 811 

110.  "Discovery"  of  a  Small  Consolidation 818 

111.  Basis  of  Consolidation 8l8 

118.  The  Necessity  for  Cash 880 

118.  One  Method  of  Raising  Cash 881 

114.  Problems  in  Forming  a  Large  Consolidation     ...  884 

115.  Basis  of  Consolidation 885 

116.  The  Interborough-Meteopolitan  Consolidation  .     .     .  886 

117.  Canada's  fixt)terlenfce  in  FAhnlng  ConwUdktlons     .      .  888 

118.  Basis  of  Consolidation 880 

119.  Dangers  of  Ovfcf-Capitallsatioil 888 

ItO.  Reorganisatioli  of  Industrial  Consolldatiohs     ...  888 

l8l.  Most  Complicated  Merger  in  Canada's  History     .     .  886 


^'  CONTENTS 

CHAPTER  XV. 
^^^      THE  UNITED  STATES  STEEI.  CORPOBXTION. 
128.     Preparing  the  Ground  »*« 

125.  Method  of  Promotion  **> 

126.  Prospectus  of  the  Corporation     .'      ." f« 

127.  Profits  of  the  Promoters  «*« 

128.  Capitalization  at  the  Beginning *** 

::•     f '^^«-  *o  the  Steel  c'orporftio.   :;••••  **f 

150.  Financial  Changes  *** 

151.  Basis  of  Capitalization *" 

132.     Operating  Policy  of  the  Corporation      .'      .*      '      *      '  !" 

ISS.     Secunt.es  of  the  Corporation  and  Their  Standing!      .*  «" 


I 


CHAPTER  XVI. 
SELLIKG  SEC.aiT,BS-XHE^pHOSP.cx.S  A.O  T„B  BA^KI.O 

184.     The  Four  Methods  of  Selling  Securities 

lie  !T"^?r*"^»**^'°^»^-^"~^^   ■  •  III 

136.  A  Typical  Speculative  Prospectus  •      •      •     266 

137.  A  Typical  Investment  Prospectus f* 

1S8.     Tne  Ideal  Prospectus  ««« 

139.  Selling  Through  Banking  House,     .*      ^      '      '      *      '     *!J 

140.  Requirements  of  Reputable  Banltin-  h        •      •      •      •     «71 

'*>.  Thd,Me.h«,.ofl„u„^^"„^;;;»'':"-  ;  :  ;  ;'^ 

CHAPTER  XVII. 
SELLING  CANADIAN  SECURITIES. 

142.     Markets  for  Canadian  Corporation  Securities 
43.     Canadian  P.„,p,,,„,  ,,,  B^.^^^,,  J  ««•     '  '     ^r. 

144.     A  Typical  Canadian  Prospectus  "      '      •      •     tSO 


CONTENTS 


ziu 


tMIB 

SECTION 

145.     Growing  United  States  Market  for  Canadian  Securities     283 
Canada's    Richest    Rural   Community    and    Fox   Farm 
Finance  


146. 


284* 


CHAPTER  XVIII. 
SELLING  SECURITIES-THE  WALL  STREET  MARKET. 

147.  The  Principal  Stock  Exchanges  of  the  United  States  291 

148.  Listing  Securities 

149.  The  Curb  Market *®* 

150.  Stock  Exchange  Methods 2®* 

151.  Importance  of  Speculative  Dealings S^T 

152.  Buying  on  Margin .      .      .  *«n 

153.  Selling  Short *^^ 

154.  Stock  Exchange  Houses  vs.  Bucket  Shops  ....  800 

155.  The  Classes  of  Wall  Street  Speculators     ....  802 

156.  A  Summary  View  of  the  Stock  Market 80S 

157.  Stimulating  Speculative  Interest *0* 

158.  Syndicate  Operations *05 

159.  Stock  Market  Manipulation ^^ 


CHAPTER  XIX. 
SELLING  SECURITIES-THE  UNDERWRITING  SYNDICATE. 

160.  Origin  of  Underwriting '0* 

161.  Advantages  of  Underwriting  to  the  Corporation     .      .  809 

162.  Advantages  to  the  Buyers  of  Securities «10 

168.     When  is  Underwriting  Advisable? 81 J 

164.  Why  Underwriting  Syndicates  are  Formed   ....  814 

165.  Three  Types  of  Syndicates «" 

166.  A  Fourth  Type— PooHng  the  Sale  of  the  Security     .  817 

167.  A  Fifth  Type— Distributing  the  Security  ....  817 

168.  The  Large  Underwriting  Houses 819 


xit 


CONTENTS 


ncrioN 
169. 

170. 

171. 
172. 
173. 
174. 


CHAPTER  XX. 
MANAGEMENT  OP  THE  UNDERWRITING 
Informal  Agreements  . 
A  Formal  Syndicate  Agreement 


SYNDICATE. 


F^r:::'*".."^  '^'-^^  ^^»^^ 


ions  of  Dndtrwitiiig  Smdicte. 
A»  E«n.pfc  of  Sp«™lrt,„  Cmienniltag 


FACE 

821 

821 

829 

880 

881 

882 


174. 

176. 

177. 

178. 

179. 

180. 

181. 

182. 

188. 

184. 

185. 


CHAPTER  XXI. 
INVESTMENT  OP  CAPITAL  FUNDS. 

Importance  of  Wise  Investmfent  . 

^ne  Installment  Method  «fn«*»-      ^    .'      *     '     '  •     **« 

Other  Possible  Methods                *«« 

HowMnchShaUbeI„vested'inFi,«lC.Dit.i;     *  '     *** 

Forms  of  Working  Capital     .      "^  ^•P*'*'?     •  •     «40 

How  Much  Working  Caoibi!  «5i.*ii  i  ^     '      '     '  •     ^*^ 

^xt^jT^H  ■  ■  ■  •■  •■  - 


186. 

187. 

188. 

189. 

190. 

101. 


CHAPTER  XXII. 
firtiWiTlON  OP  GROSS  EARNINOa 
Determination  of  Income  . 

Honesty  in  StaUngOtos.  £.„,•; «*» 

What  Are  Operating  Expenses?        «« 

Necessity  for  Depreciation  Reserres* "° 

Income  From  Other  Soopom  -«j  r^  j     '     '     '     *     •  **J 

H«Moc»sunk.?:?."r;::s;t--  •  •  •  ••♦ 

*        *        •  905 


pr 


CONTENTS 


192.  Variability  of  Profits .      .      .     aoo 

193.  Regularity  of  Pividends  Desirable «60 

194.  Prudence  in  Paying  Dividends ?     '^^ 


CHAPTER  XXIII. 
BETTERMENT  EXPENSES. 

195.  Two  Classes  of  Betterments ^^^ 

196.  Sources  of  Funds  for  Betterments '64 

197.  Appropriations  from  Earnings '°^ 

198.  Objections  to  This  Method *^^ 

199.  The  Attitude  of  Stockholders 866 

200.  The  Case  of  the  Lehigh  Valley  Railroad     ....  868 

201.  Policy  of  the  Union  Bag  and  Paper  Company  ...  872 

202.  Borrowing  Funds  for  Betterment? 873 

203.  Policy  of  the  Pennsylvania  Railroad     .....  974 

204.  General  Conclusions  as  to  the  Financing  of  Better- 

ments         ^''^ 


CHAPTER  XXIV. 
CREATION  AND  USE  OP  A  SURPLUS. 

80S.     Definition 877 

206.  Four  Sources  of  Surplus 878 

207.  The  Fifth  Source— Saving 879 

208.  Policy  of  the  "Trusts" 881 

209.  How  Should  Surplus  be  Invested? 882 

21Q.     The  Surplus  as  a  "Rainy  Day  Fund"     .....  «82 

21 L     Putting  the  Surplus  Back  Into  the  Property     ...  885 


218. 
SIS. 


CHAPTER  XXV. 
DISTRIBUTION  OF  THE  SURPLUS. 

Effect  of  a  Surplus  on  Assets  and  Dividendf 
Distribution  Through  Stock  Watering  .      . 


S87 
889 


xvi 

SECTION 

214. 

215. 

216. 

217. 

218. 
219. 
220. 
221. 


CONTENTS 


Cashing  the  P,ivilege-Thec„r       ^  J"^««tme„t 
„    **       ^  "«  *>"osequent  Sale 
"-Short  Selling 

..        "~S«Je  of  Old  Stock 

•  •  •  , 


rAGi 
391 

392 

393 

394 

395 

395 

397 

399 


222. 

223. 

224. 

225. 

226. 

227. 

228. 

229. 

230. 


CHAPTER  XXVI 

Fraudulent   Contracts  "      '      *      ' 

MLe'Tt^r  f-«*«"e  B-iness 
Canada  Fairl.  P-Z  "^^e™  Common  ? 


2«i.  cand:F:irr^  "^        • 

i-airly  Free  from  Manipulation  . 


CHAPTER  XXVII. 

mmPULATION  BY  DIRECTORS. 
Usual   Methods 

Fraudulent   Contracts " 

Attitude  of  the  Courts      *      '      '      "      * 

An  Acc„„„,.„,.,  ob,er,.,i„„,     .'     '     ' 
remedies  for  This  lCi»A    *  », 

The  n-n  ?  ^'^  Corporation   . 


40] 

401 

402 

403 

404 

*D5 

407 

410 

412 

418 


232. 

233. 

234. 

235. 

236. 

237. 

238. 

239. 

240. 


414 

415 

418 

419 

420 

423 

424 

426 

428 


CONTENTS 


zvu 


m 

02 

OS 

04 

35 

)7 

0 

S 

8 


■KnOll  PACE 

241.  Form  of  Annual  Stateipents  in  Canada 481 

242.  What  Should  Be  InclaJed  in  the  Statement?     .      .      .  482 
248.     Quarterly  Statements 488 


CHAPTER  XXVIII. 
MANIPULATION   BY  AND   FOR  STOCKHOLDERS. 

Cheating  Creditors 485 

The  Chicago  and  Alton  Deal 486 

Manipulation  Through  Subsidiary  Companies   .  488 

Central  of  Georgia  Income  Account 489 

Squeezing  the  Minority  Stockholders 441 

A  Complicated  Real  Estate  Proposition 448 

Robbing  a  Partnership  to  Pay  a  Corporation  445 

Remedies  for  Manipulation 448 


244. 
245. 
246. 
247. 
248. 
249. 
250. 
251. 


252. 
258. 
254. 
255. 

• 

256. 
257. 

258. 
259. 
260. 
261. 


CHAPTER  XXIX. 
INSOLVENCY  AND  RECEIVERSHIPS. 

Two  Types  of  Insolvency 450 

Causes  of  True  Insolvency 451 

One  Cause  of  Legal  Insolvency — ^"Lack  of  Capital"  458 
The  Case  of  the  Detroit,  Toledo  &  Ironton  Railway 

Company 454 

Additional  Causes  of  Legal  Insolvency 454^ 

Two   Methods   of  Handling  Insolvency — Bankruptcy 

and  Dissolution 457 

A  Third  Method — Appointment  of  a  Receiver  .      .      .  459 

Duties  of  a  Receiver 460 

Receiver's  Powers 462 

Business  Failures  in  Canada 468 


CHAPTER  XXX. 
PRINCIPLES  OF  REORGANIZATION. 

968.     Reasons  for  Reorganisation 466 

268.     The  Formation  of  Committees 468 


CqitfTENTS 

SECTION 

264.     Why  Not  Foreclose?   . 

365.     Problems  Confrontino-  «.»  d *' 

m.     Necessity  for  cTs^  ®^'»-""««<"'  Commttec  .     v, 

III'     ff"*  ^-"'^  ^3^  Assessments     ['■'■•     *^ 

«e8.     Reducing  Fixed  Charges  .  *' 

260.     Capitalization  of  the   »»«,»     •   \   L 47 

48: 

CHAPTER  XXXI. 

^'^^^  ^^WCAL  REORGANIZATIONS. 

«7»-  *"•»*  ReorganizaUon  of  th^  <?»«*  r-  ,  '  *  '  •  «« 
273.  Second  Reorgani,a«on?nd%ttsl"'"'^^-^*'^  «- 
275      LTrf!?^^^'''^-'^  System         *«« 

276.     Westmghouse  Reorganisation  *9» 

498 


277. 

278. 

279. 

280. 

281. 

282.. 

S8S. 


CHAPTER  XXXII. 

CANADIAN  REORGANIZATIONS. 
Canadian  Reorganisations  and  Sacrifi^.  f  o 
Two  Canadian  Reorganization,      "'  °'  ^**"''«^   '     ^0* 

p"*:f  *'/'"'"'*^'"«  of  Reorga„izati;n '°* 

Further  Financing  504 

Financing  Which  Raised  Problems *^ 

Question  of  Bondholders- Majority         *«'' 

As  to  a  "Bare  Majority"  .  «09 

Qui*  Questions •  «10 

51» 


VAGI 

470 
471 

474  I 

475  I 
478  f 
480  I 
488  ^ 


488 

487 

489 

492 

495 

498 


502 

502 

^04 

506 

507 

509 

510 

51$ 


CHAPTER  I 

THE  CORPORATE  FORM 

1.  "Non-stock"  corporations. — Everybody  knows  in 
a  vague  way  that  a  cornoration  is  an  association  of  in- 
dividuals formed  to  carry  on  an  enterprise.  Compara- 
tively few  people,  however,  understand  just  what  the 
corporation  is  in  the  eyes  of  the  law  or  the  extent  and  the 
limitations  of  its  activities.  Obviously,  the  first  step  in 
the  study  of  corporation  finance  should  be  an  examina- 
tion of  the  powers  and  possibilities  of  this  peculiar  and 
wonderfully  effective  form  of  organization. 

Corporations  fall  into  two  distinct  groups.  There 
are,  first,  corporations  without  capital  stock,  or  "non- 
stock" corporations;  to  this  class  belong  ahnost  all 
churches,  hospitals,  chartered  clubs,  universities  and 
other  strictly  social  and  charitable  organizations.  The 
prime  characteristic  of  such  corporations  is  that  the 
members  share  equally  in  all  the  privileges  of  member- 
ship without  regard  to  the  amount  of  money  that  each 
may  have  contributed.  There  is  no  arrangement  for 
transacting  a  money-making  business  and  distributing 
profits  or  losses.  In  fact,  non-stock  corporations  exist  , 
either  for  the  common  benefit  of  all  the  members  or  for 
the  purpose  of  serving  the  public  at  large.  Many  in- 
teresting questions  as  to  the  rights  and  powers  of  such 
corporations  might  be  discussed;  but  the  discussion 
would  be  out  of  place  in  this  volume. 

2.  "Stock"   corporations.— We   are   here   concerned 
only  with  the  second  class,  namely,  "stock"  corporations; 

c-vi-i  1 


I 


2 


CORPORATION  FINANCE 


to  this  class  belong  all  business  corporations      Two  «« 

holders,  ,„  proportion  to  the  number  of  shares  eLhZ. 

stockLXtanZ-  T,^'™"'  stockholder;  each 
tothee.te.-Ar„ltfoS^^^^^^ 

4oSC:aVd?/.rtJrj-4 -"£^^^ .» 

of  the  Unit^  Stat^C^t  S^fr     ■i^^'^" 

aenmtion  that  is  almost  as  »ell-knr.«m  «,  ^i.-  *  r      . 
Marshall's  in  the  followinrwords-A  ^    '^  i"'*''!^ 
an  artificial  person  created  fo7ptsmfn^1^nT  '? 
succession  certain  riKlits  which  T.®  'n  perpetual 
naturalpersonsonlv  «o  Mf„n  '  ♦■!"*'  "'"^'"'^  "" 
You  will  note  tha   t'lrdll  v       *'  ^"^^"^  "' *™^-" 
striking  distiLiveVelre  "  r  ""^    '^'  ""'  ""'^* 
its  artificial  pXhtv    Vhl  tCT'''""'  "'™^'^- 
or  being  i„  itsC,  ^^fJ^CXZ::Z^ 


THE  CORPORATE  FORM  S 

and  own  it.  Let  us  review  some  of  the  results  of  this 
legal  fiction  that  the  creation  of  a  corporation  brings 
into  the  world  a  new  person, — artificially  created,  to  be 
sure,  but  yet  endowed  with  many  of  the  powers  of  an 
ordinary  human  being. 

In  the  first  place,  as  the  corporation  has  an  existence 
apart  from  the  lives  of  any  or  all  its  owners,  it  is  not 
broken  up  by  the  death  or  withdrawal  of  any  owner. 
In  the  second  place,  the  corporation  has  the  right  to  buy 
and  sell  and  contract  debts  in  its  own  name  and  for  itself; 
it  may  even  owe  money  or  lend  money  to  some  or  all  of 
its  owners.  In  the  third  place,  it  may  sue  and  be  sued 
in  the  courts,  without  thereby  involving  any  of  its 
owners.  In  the  fourth  place,  it  may  enter  into  all 
kinds  of  legal  contracts,  just  as  an  individual  might 
do. 

4.  The  fiction  of  "corporate  entity"— YieTe,  then,  is 
the  first  and  most  fundamental  fact  about  the  corpora- 
tion for  the  reader  to  grasp  and  keep  always  clearly  in 
view,  that  it  is  a  separate,  distinct  artificial  person.  It 
is  true  that  within  the  last  few  years  the  courts  of  uie 
United  States  have  shown  a  strong  tendency  to  go  be- 
hind this  artificial  personality  and  to  throw  responsibihty 
on  the  owners  and  managers  of  a  corporation,  especially 
in  case  of  fraud.  Clark,  the  author  of  a  standard  legal 
work,  says: 

That  a  corporation  is  a  legal  entity,  separate  and  distinct 
from  the  members  who  compose  it,  is  a  mere  legal  fiction,  in- 
troduced for  the  convenience  of  the  corporation  in  transacting 
business,  and  of  those  who  do  business  with  it ;  and,  when  urged 
to  an  intent  and  purpose  not  within  its  reason  and  policy,  the 
fiction  will  be  disregarded,  and  the  fact  that  the  corporation  is 
really  a  collection  of  individuals  will  be  recognized,  even  at  law. 
Courts  of  equity,  in  every  instance,  look  behind  the  corporate 


I\' 


*  COHPOllATION  FINANCE 

entity  and  rocognize  the  individual  member,  and  will  do  ,„  when- 
ever  justice  requires. 

Yet  the  fact  remains  that  the  corporation's  existence 
property  contracts  and  debts  all  adhere  to  the^^rt 
tmn  Itself  and  not  to  the  individuals  who  together^^ 
the  corporation.  It  is  true,  also,  that  this  artifidd  Zr- 
son,  the  corporation,  has  neither  mind  nor  body  and  can- 
no  therefore  think  or  act.  The  law,  however  eaX 
^ts  over  this  difficulty  by  treating  the  manl^rs  and 

5.  Corporations  in  ancient  nations.~Thk  fiction  of 

artiflcal  per^naiity  seems  to  be  at  first  sight  an  un 

necessary  and  even  absurd  idea,  and  the  resutethat  foT 

ow  from  the  adoption  of  this  fiction  appear  more  hkl 

the  spmnm^  of  legal  cobwebs  than  the  worKng  out 

reveals  that  the  corporate  form  substantially  as  it  existe 
to-day  has  been  used  by  many  ancient  and  mS^ 
nafons.     It  seems,  therefore,  that  there  must  h^ZZ 
«food  reason  or  reasons  for  its  widespread  use     The 
«d,a»log,sts  tell  us  that  as  far  back  L  the  p™"    ^L' 
days  of  Babylon  the  inhabitants  of  that  ill-fat^  'S^ 
m  their  commercial  transactions  used  corporat^onsTmZ 
what  as  we  use  them  now.     The  Romans  also  dTveWl 
and  made  great  use  of  the  corporate  form  of  orglS 
enterprises.     Indeed,  it  is  asserted  by  BlackstonHnf 
was  at  one  time  universally  believed,^^ IS  °X' 
corporations  are  descendants  in  a  direct  line  Tthc 
ancient  Roman  corporations.    Althouo-h  f h  .  r  ■ 

no  longer  fully  acpted,  it  remats  tf«,    "  h  "Sa:^ 
aw  with  regard  to  corporations  has  had  consider^ 
nifluence  in  the  development  of  our  modem"^"^ 
law.    Without  going  further  into  this  historicSy 


THE  CORPORATE  FORM  0 

which  is  a  little  outside  the  scope  of  this  hook.  >  may 
lay  down  this  generalization,  that  in  almost  every  great 
active  commercial  nation  the  corporate  form  of  organ- 
ization has  sooner  or  later  come  into  existence.  It  must, 
then,  we  may  be  sure,  have  some  clear  and  important 
business  advantages. 

6.  Popularity  in  modern  times. — This  conclusion  is 
confirmed  when  we  reflect  that  along  with  the  marvelous 
business  development  of  the  last  century  there  has  been 
apparent  a  more  than  proportional  increase  in  the  num- 
ber and  importance  of  corporations.  At  first  only 
large  enterprises,  such  as  railroads,  steamship  companies 
and  great  manufacturing  establishments  were  so  organ- 
ized. Later  the  smaller  factories  and  wholesale  estab- 
lishmeiits  followed  the  lead  of  the  larger  concerns. 
Finally  within  the  last  few  years  we  have  witnessed 
both  in  Europe  and  particularly  in  this  country  the 
extension  of  the  movement  to  small  manufacturing  and 
retail  establishments.  The  drift  in  this  direction  is  so 
apparent  that  it  need  not  be  dwelt  upon  at  any  length. 
Every  reader  of  this  book  may  look  around  and  see  with- 
in his  own  circle  numerous  concerns  in  corporate  form 
which  were  conducted  a  few  years  ago  by  individuals 
or  partnerships.  Unless  this  tendency  receives  some 
unexpected  check  it  will  not  be  many  years  before  the 
corporate  form  will  be  adopted  by  almost  every  business, 
large  and  small,  in  the  United  States. 

7.  Adaptability  to  raising  large  amounts  of  capital. — 
Evidently  there  must  be  great  advantages  in  the  corpo- 
rate form;  otherwise  the  landslide  toward  it  would  long 
ago  have  been  stopped.  It  will  be  worth  while  to  review 
briefly  some  of  these  advantages. 

Originally,  as  has  been  said,  corporations  were  con- 
fined almost  altogether  to  large  enterprises  and  were  used 


.^ 


6 


CORPORATION  FINANCE 


principally  because  of  the  facilities  which  thev  afforcle^ 

..v«.™  .t  >».  u,i„  .„'"•  ^,;'^  ^«~>  »n™i 

were  able  indivulnoiNr  *■     ,  i        *^"  "  °"^  <^t  these  men 
wealth  do  not  consider  it .  Jvislble  to  1  aU  thei     ^"'" 

more  tha„"?::;:b:,:r  tirr  °"  '-^  ^^^  -"^ 
i".  to,x  t„e  ^^"i::tfoT:;r  t??'"«- 

quired   for  everv   n-r^o*       *        •    '-apitai  tliat  are  re- 

extraordina4"»i„XceTr:^,  l™"'^  ^  <«" 
«ealth,  who  might  coneeivabr^^L"!"  °^"™"^".^ 
partnership  a  biff  railroad  nr  ,  i  •    .  *'™".  »"''  own  in 

able  to  lmLnifernX:,*^f^:;tr„t'  *™^''  ''^'! 
to  co-operate  effipi'pntK    •       "'"^^^"^es  of  opinion  and 

'"Story  of  the  ^orM  w  I„t  „o"t  «;!,"'''*  T"?'"'™'" 
of.  say,  a  billion  or  e,-en  h  tfT^  '  *  ^'"«'^  ">»"'"'« 
a  Lundred  million-dollars  of  eapitlTr^''^  T  ''"" 
aifcd  under  a  partnership  aK^ment  It  '  T' 
rememlwr  in  this  connection  ^^T  J  "  "■•■"  '" 
dividual  fortunes  are  ^Jr  I  ,  "  ^^  «'^»''»'  '"- 

wealth   of  a   TJlTZX^Tt  -t^""!  *°'"        ^ 
Furthermore,  of  these  individLlf    1  "'^    ^''"<^'- 

part  ordinarilv  is  freTa   „  v  onl  f"'*Tl""'^  "  """"         i 
vested  as  the  ;,„  ner  « ill       '  ""'  *°  "*  "'"'  "'  '"" 


THE  CORPORATE  FORM 


The  corporate  form,  on  the  other  hand,  has  infinite 
possibihties  so  far  as  the  raising  and  managing  of  capi- 
tal is  concerned.  Any  number  of  people,  large  or 
small,  may  contribute  funds.  The  American  Tele- 
phone and  Telegraph  Company,  for  example,  has 
over  54,000  stockholders,  the  Pennsylvania  Railroad 
Company  over  84,000,  and  the  United  States  Steel 
Corporation  not  far  from  125,000.  A  large  num- 
ber of  owners  of  a  corporation  does  not  tend  to 
break  up  and  render  inefficient  the  management,  for 
the  control  of  whatever  capital  the  owners  contribute  is 
kept  in  the  hands  of  the  officers  of  the  corporation. 
Thus  the  corporation,  without  losing  in  efficiency,  may 
reach  out  into  the  highways  and  by-ways  of  the  land, 
draw  its  capital  from  a  thousand  or  from  a  hundred 
thousand  individuals  and  heap  up  vast  aggregations 
of  capital  that  could  not  possibly  be  obtained  in  any 
other  manner.  For  this  reason  it  is  inevitable  that  the 
corporate  form  should  be  used  in  the  financing  of 
practically  every  large  enterprise. 

This  advantage  of  corporations,  that  they  are  able 
to  collect  and  to  make  use  of  the  small  contributions 
of  many  individuals,  though  most  prominent  in  great 
undertakings,  is  by  no  means  to  be  overlooked  in  the 
case  of  smaller  enterprises.  Frequently  an  inventor  or 
a  retail  dealer  or  any  small  business  man  who  needs  a 
few  hundred  or  a  few  thousand  dollars,  could  not  uo* 
tain  it  from  his  own  immediate  relatives  and  friends. 
The  same  man,  perhaps,  may  easily  raise  the  capital  he 
requires  by  organizing  a  corporation  and  selling  small 
interests  to  a  considerable  number  of  people.  Many  a 
business  man  has  thus  obtained  necessary  capital  which 
he  has  made  the  foundation  of  a  fortune. 

8.  Permanence, — The   second   important   advantage 


8 


CORPORATION  FINANCE 


i  I 


of  ihe  corporate  form  is  permanence..    Wlien  an  in 
iv^dual  owner  of  a  business  die,,,  Lis  business  dierwth 
him.    It  may,  to  I«  snre,  be  carried  on  bv  bis  famiWor 
bought  by  strangers;  on  the  other  hand,  t  may  ™  «.a 
no  praebeable  method  of  disposing  of  it  exi ot  at  »„ 

uie  mrerest  ol  tJie  deceased  partner      Tn  c« 

Tf  *hJ         •  '  *^^^  ^^^^*^  '^  not  clearly  defined 

o  1  ueceased  partner  may  be  denrivprl  r.f 

Heparin,   t  e";^  -t'"'  ""'"''''"  «"'^^- 
managing  the  bus  ne        Ti^"^^',  ™*'"^^  ^°' 

becomes  bankrunf   ;.  oil        ?  !    ,         ^'  ^''''''*^  ""^'^  >* 

"ic.>  uankrupt,  is  allowed  to  lapse  or  i«  v«l.,«*    -i 
(bsso  ved.     Hie  dpnfh  .^^  ^  ^oiuntardy 

per  cent  of  tl,t^k„f  ,,""''  "'""'  '™"  '"  '"  """•'  »» 
«.e  eorpora^ont,  f  '  It'  U  I™"T«"7  ,""'  '"^«' 
creature  „f  the  law  not  u  ie"  to  , hf ''"« '">"  " 
human  existence     If  :      """J'^'^'.  'o  the  infirmities  of 

dies  or  wiH  d'ws  a    f  "  "''"'"""*'  "'"*  '^  ""«  "««' 

As  the  c«:;:^  raTa;"r  '"..'""^■'"^  ^'■•'-"• 

own  it  and  as  «>nW       ,l7in  T  m"  '^T'  '^'"' 
or  withdrawal  of  an  owrtrrt-aTrirtt 


THE  CORPORATE  FORM 


9 


machinery,  and  the  death  or  withdrawal  of  an  officer 
means  simply  that  someone  else  must  be  found  and  ap- 
pointed to  the  position. 

9.  Centralization  of  control— This  brings  us  to  the 
'third    important    advantage    of    the   corporate    form, 
namely,  its  centralization  of  power  and  responsibility. 
In  this  particular  feature  it  cannot  be,  of  course,  supe- 
rior to  individual  ownership,  but  it  is  far  ahead  of  the 
partnership.     As  the  law  does  not  recognize  in  the  part- 
nership anything  but  a  gi-oup  or  association  of  individ- 
uals, it  follows  that  each  partner  is  empowered  to  conduct 
the  business,  to  buy  and  sell  the  partnership  assets,  to 
make  binding  contracts  and  incur  debts.     Ordinarily, 
to  be  sure,  the  partners  mutually  agree  to  a  fixed  division 
of  duties  and  powers,  but  this  division  is  not  supposed 
to  be  known  or  to  be  binding  on  outsiders.     Each 
partner,  so  far  as  his  dealings  with  outsiders  are  con- 
cerned, is  the  whole  partnership.     Obviously,  therefore, 
no  partnership  should  ever  be  formed  except  between 
persons  who  have  entire  confidence  in  each  other;  and 
even  then  a  partnership  often  proves  an  unsafe  and 
inefficient  method  of  conducting  business.     Except  by 
mutual  agreement  binding  only  on  themselves,  to  repeat, 
there  is  no  clear-cut  division  of  powers  and  responsi- 
bilities. 

Under  the  corporate  form,  on  the  other  hand,  busi- 
ness can  be  transacted  only  by  the  duly  appointed 
officers;  no  owner,  unless  he  is  also  an  officer — even 
though  he  hold  almost  all  the  stock— has  any  authority 
to  transact  business  for  the  corporation.  Each  of  the 
officers  of  the  corporation,  as  is  explained  in  the  chapter 
on  "Interior  Organization,"  has  his  sphere  of  duties  care- 
fully defined,  l)oth  within  the  corporation  and  outside. 
l*er8ons  not  connected  with  the  corporation  are  expected 


10 


CORPORATION  FINANCE 


.1 


y 


to  have  their  dealinffs  only  with  the  duly  authorized 
offleers.  and  if  they  do  not  exereise  r^asonabk  t^"' 
th,s  respect  may  find  whatever  agreements  or  contract 

by  the  reader  after  a  study  of  the  chapters  on  ageney 
n  the  ™lume  on  Commercial  Law  Furthem^^ 
the  relabons  of  the  corporate  officers  to  each  otC  are 
clearly  defined  and  the  gradations  of  authority  are^ 
marked  that  each  one  may  understand  clearly  jU  how 
far  he  is  empowered  to  act  on  his  own  judgmen  a^d 
what  questions  he  should  refer  to  his  oflicial^;^!:^^ 

m  delegation  of  power  is  so  obvious  that  it  need  not  be 
cam  sTit^  a7 '"'^-t  ..^  -"—««"  -por:«on 

:n  ;id- c- "i^:^  :;r '^  ^-^^  --i  -othness 

JJ'JT"'''''"''''''''  °f  ""■'"■'•"'"/'-A  fourth  advan- 
tage  of  the  corporate  form  is  the  ease  with  which  ite 
ownership  may  be  transferred.  An  individuJowne^ 
who  desires  to  sell  his  pro,«rty  must  find  a  putw^or 
all  of  It  at  one  and  the  same  time.  A  oartiJ  X  T 
sires  to  sell  his  interest  in  the  firm  mustC  ma^e  ^t 

ina>  oe  a  difhcult  matter,  or  must  find  a  purchaser  who 
offer,  satisfactorj-  terms  and  is  personally  aeceZbir to 

dm  cult.  Altogether  the  problem  of  withdrawing  funds 
that  have  bec-n  invested  in  an  individuallyK>wned  pr^l 
erty  or  m  a  partnei^hip  is  almost  alwaysT.rd'^Z 
frequently  ii.sohible.  Under  the  corporal  f^  the 
problem  is  much  simpler.     The  ownership  of  a^r^ 

the  least  with  the  stabili^^fre:;^- ^^^^^^^ 


THE  CORPORATE  FORM 


11 


of  several  shares  need  not,  therefore,  find  any  one  person 
to  take  all  his  property  off  his  hands;  he  may  sell  a  few 
shares  to  one  man,  one  or  two  to  another,  and  so  on,  and 
thus  dispose  of  his  property  piecemeal.     Furthermore, 
as  the  corporation  is  managed  directly  by  the  officers,  not 
by  the  owners,  no  consideration  ordinarily  need  be  given 
to  the  question  as  to  whether  or  not  a  prospective  buyer 
is  a  good  business  man  or  is  acceptable  to  the  other 
persons  interested  in  the  corporation.     Women,  old  men, 
administrators  and  trustees  of  estates,  institutions  of  all 
kinds— all  are  possible  purchasers  of  corporate  securities. 
Thus  the  owner  of  corporate  shares  finds  his  market 
much  broader  and  his  facilities  for  selling  much  better 
than  does  the  owner  of  a  partnership  interest.     The  se- 
curities of  large  corporations  are  constantly  dealt  in  on 
the  stock  exchanges  of  large  cities,  and  thus  a  continuous 
and  easily  accessible  market  is  afforded  to  every  owner. 
11.  Limited  liahility.—The  fifth  and  last  important 
advantage  of  the  corporate  form  is  the  fact  that  the 
liability  and  possible  loss  of  each  owner  is  limited.     Gen- 
erally speaking,  the  owner  of  any  corporation  security 
is  safe  in  reflecting  that,  though  the  security  may  become 
worthless  and  he  may  lose  all  that  he  paid  for  it,  he 
cannot  possibly  lose  more  than  that  amount.     The  reader 
may  perhaps  think  that  to  the  owner  of  the  stock  of  a 
failed  corporation  this  statement  affords  but  cold  com- 
fort; but  compare  his  situation  with  that  of  a  partner  in 
a  bankrupt  firm.    The  partner  may  not  only  lose  all 
that  he  invested  in  the  firm,  but  in  addition  is  personally 
liable  for  all  the  unpaid  debts  of  the  firm.     As  has  been 
explained  above,  it  is  possible  that  these  debts  may  have 
been  foolishly  or  even  fraudulently  contracted  by  some 
other  partner;  yet  that  fact  would  not  relieve  any  other 
partner  from  his  personal  liability.    No  doubt  most 


13 


CORPORATION  FINANCE 


f 


readers  of  this  paragraph  will  call  to  mind  instances  in 
their  own  experience  of  individual  owners  or  of  partners 
in  disastrous  enterprises  who  have  lost  everything  thev 
owned,  including  even  their  homes  and  most  of  their 
personal  property,  by  the  failure  of  such  enterprises. 
If  a  corporation  fails,  on  the  other  hand,  and  its  debts 
prove  greater  than  its  assets,  the  creditors  have  no  claim 
on  the  property  of  the  stockholders  outside  the  failed 
business. 

An  important  exception  to  this  principle  of  limited 
liability  exists  m  the  cace  of  stockholders  of  national 
banks.     They  are  individually  liable  in  case  of  failure 
not  only  for  their  investment  but  for  an  additional  sum 
equal  to  the  par  value  of  their  holdings  of  bank  stock. 
A  similar  rule  applies  in  Minnesota  to  stockholders  of 
most  corporations   and   there  are   one  cv  two   other 
exceptions  which  are  referred  to  in  Chapter  IV.     Even 
in  such  cases,  however,  though  the  liability  of  stock- 
holders  is  somewhat  greater  than  with  the  ordinary  cor- 
poration, it  is  still  strictly  limited. 

xXo  doubt  this  principle  of  limited  liability  has  been 
one  of  the  main  advantages  of  corporations  that  has  led 
to  their  formation  in  a  great  many  cases,  and  especially 
has  encouraged  in  recent  years  the  widespread  move- 
ment to  change  partnerships  into  corporations.     No 
business  man,  especially  one  who  has  considerable  per- 
sonal property  and  perhaps  is  advanced  in  years,  hkes  to 
reflect  that  at  any  moment,  through  the  fraud  or  mis- 
management of  some  subordinate  or  partner,  or  throuifh 
some  unavoidable  natural  calamity,  he  may  be  compelled 

\^7\l^  5''  ^''"''  ^""^  P""'^"^^  P^P^^ty  '"  order  to 
satisfy  the  demands  of  business  creditors.  The  corpo- 
rate form  of  business  relieves  him  of  this  haunting 


THE  CORPORATE  FORM 


13 


The  prominent  advantages  of  the  corporate  form, 
which  have  brought  about  its  great  extension  in  recent 
years,  may  then  be  summed  up  as  follows: 

(1)  Flexibility.  The  owners  of  a  corporation  may 
be  few  or  numerous.  This  makes  the  corporate  form 
especially  well  adapted  to  collecting  large  amounts  of 
capital  by  means  of  small  contributions  from  a  great 

many  people.  . 

(2)  Permanence.  The  life  of  a  corporation  is  not 
dependent  on  the  life  or  on  the  caprice  of  any  individual. 

(3)  Centkalization  of  control.  Under  the  cor- 
porate form  the  officers  of  the  corporation  within  care- 
fully defined  limits  exercise  complete  control. 

(4)  Transferability  of  ownership.  Corporate 
shares  may  be  readily  sold  either  in  a  block  or  piecemeal 
and  have  a  wide  market. 

(5)  Limited  liability.  The  corporation  alone, 
with  certain  minor  exceptions,  is  liable  for  its  own  debts 
and  the  shareholders  cannot  lose  more  than  their  orig- 
inal investment.  . 

12.  Disadvantages  of  the  corporate  form.— In  view  ot 
these  advantages  it  may  be  asked  why  all  kinds  of  busi- 
ness without  exception  are  not  organized  under  the  cor- 
porate form.  The  answer  is  that  certain  minor  disad- 
vantages, which  in  some  instances  are  sufficient  to  offset 
the  advantages  named,  are  inseparable  from  corpora- 
tions.   These  disadvantages  may  be  briefly  summed  up 

as  follows:  .  . 

(1)  Increased  expense.  All  states  impose  certain 
incorporation  fees,  license  and  franchise  *axes  on  corpo- 
rations, which  taxes  are  In  addition  to  the  ordinary  state 
and  local  taxes  on  property.  These  taxes  are,  however, 
uniformlv  small.  The  United  States  Government  also 
imposts 'a    tax    on   corporate    income.    In    addition, 


14 


CORPORATION  FINANCE 


legal  assistance  is  almost  always  nece«flr.r  ;,,  f       • 

hampered  at  thn  jly  KluthoritZ  ^  """'"'"'* 
ations  that  would  be  ptoSi^mT  tI  l"^  ""  °^'- 
«cia,  objection  S:;t  Jd'^  d'^S-^ 

T..po.tai:f-U™d:^--^^^ 
(3)  Limited  cbedit.    A  lender  of  money  would  of 

fonner  ca.e  is  unlimited,  and  in  the  latte^^t  ^hL 

i^lTeSio"""'^"-  .^""^ "  p"'-hT;:hlt 

>  converted  mto  a  corporation  w  11  sometimes  be  em 
barrassed  more  or  less  by  reluctance  of  its  Editors  To' 

™rlr  ™"t«  r"" "'  ''^^'y  -  bcforr?^:,;? 

lersion  This  objection,  which  is  of  importance  usiiallv 
only  in  the  case  of  a  small  and  closely  heW  busTess  miv 
be  overcome,  if  desired,  by  the  offi<vr,  or  certa"n  stek 

tn  f  pa^rrt  '"'"T'  ""^  -I'-'wfnrstia" 

"Ills  payable.    By  so  doing  they,  of  course,  lose  the 


THE  CORPORATE  FORM 


15 


advantage  of  limited  liability,  but  they  retain  all  the 
other  advantages  of  the  corporate  form.     There  are 
some  business  activities,  however,  in  which  the  personal 
element  is  so  prominent  as  to  make  unlimited  liability 
desirable.    A  firm  of  accountants,  for  instance,  could 
not  be  changed  to  a  corporation  without  forfeiting  to 
some  extent  the  confidence  of  the  business  pubUc,  for 
every  public  accountant  is  and  ought  to  be  personally 
liable  to  the  fullest  extent  for  the  honesty  and  accuracy 
of  his  work.     The  same  thing  may  be  said  of  bankers 
and  engineers,  and  to  some  extent  of  business  advisers 
and  systematizers;  for  such  activities  the  corporate  form, 
on  account  of  its  limited  liability  feature,  is  ill-adapted. 
(4)   Governmental  control.     Some  concerns  are 
strongly  averse,  for  good  reasons,  to  any  pubhcity  what- 
ever as  to  their  operations  and  financial  results.     They 
may  perhaps  be  making  so  much  money  that  they  desire 
to  keep  it  secret  in  order  to  avoid  attracting  competitors; 
or  their  real  business  may  be  quite  different  from  their 
ostensible  business,  and  they  would  not  desire  to  attract 
attention  to  this  fact  by  the  inclusion  of  unusual  powers 
in  articles  of  incorporation.     For  fear  of  governmental 
supervision,  therefore,  they  retain  the  partnership,  even 
with  all  its  disadvantages. 

The  reader  will  readily  see  that  this  list  of  disadvan- 
tages of  the  corporate  form  does  not  include  anything 
of  great  importance  to  most  legitimate  kinds  of  business. 
Certainly  the  disadvantages  are  of  little  weight  in  most 
cases  in  comparison  with  the  obvious  and  substantial 
gains  that  may  be  had  by  adopting  the  corporate  form. 
We  are  justified  in  concluding,  therefore,  that  the 
tendency  toward  the  corporate  form  of  conducting  busi- 
ness, which  has  been  referred  to  above,  will  not  dimin- 
ish, but  rather  will  increase  in  the  coming  years.    The 


16 


CORPORATION  FINANCE 


corporation  is  the  efficient  twentieth  century  means  of 
conducting  business.  In  city  and  in  country,  from  the 
captains  of  finance  to  the  smallest  units  in  the  army  of 
business,  m  transportation,  in  manufacturing,  in  trad- 
ing, even  m  farming,  the  corporation  has  come  to  be 
recognized  as  the  best  form  yet  discovered  for  organizing 
the  production  of  wealth. 

To  confess  oneself  ignorant  of  the  nature,  the  func- 
tions,  the  abuses  and  the  possibilities  of  this  mighty  in- 
strument is  indeed  a  confession  of  business  inefficiency 
and  narrowness.  The  pages  that  follow  are  to  be  de- 
voted to  a  (liscussion  of  the  formation  and  management 
of  corporations  which,  it  is  hoped,  will  place  this  truly 
important  and  somewhat  difficult  subject  in  a  clear  light 
before  our  readers. 


CHAPTER  II 

LEGAL  STATUS  OF  THE  CORPORATION 

13.  Defining  and  controlling  instruments.— The  cor- 
poration, we  have  said,  is  a  "creature  of  the  law,"  and  this 
statement  is  to  be  taken  literaUy.  This  artificial  creature 
has  no  existence,  no  powers,  no  privileges,  no  duties,  ex- 
cept those  which  are  conferred  upon  it  either  by  express 
statement  or  by  implication.  The  artificial  creature,  in 
other  words,  does  not  have  what  we  may  call  the  natural 
rights  of  an  individual  to  live  unmolested  and  to  pursue 
whatever  objects  he  pleases,  so  long  as  the  rights  of  oth- 
ers are  not  interfered  with,  but  only  artificial  rights.  In 
order  to  determine  in  any  particular  case,  therefore,  what 
a  corporation  may  or  may  not  do  and  what  its  standing 
is,  we  must  look  to  the  particular  instruments  which 
give  it  being  and  control  its  actions.  These  instruments 
in  everj-  state  in  the  Union  are  three  in  number: 

(1)  The  Constitution  of  the  state. 

(2)  The  General  Corporation  Act. 

(8)   The  Charter  of  each  particular  corporation. 
Supplementing  the  charter,  practically  all  corporations 
have  a  set  of  by-laws  for  their  own  guidance.    In  order 
to  understand  the  legal  status  of  a  corporation  we  must 
consider  briefly  each  of  these  instruments. 

14.  Common  law  of  corporations. — It  must  be  borne 
in  mind,  in  connection  with  what  follows  in  this  chapter, 
that  corporations  of  one  kind  or  another  have  been  in 
existence  for  a  very  long  time,  and  that  the  courts  of 
England  and  of  the  United  States  have  given  a  large 

C— VI— 2  W 


18 


CORPORATION  FINANCE 


number  of  decisions  dealing  with  the  duties  and  powers 
of  corporations.     These  decisions  form  the  great  body  of 
common  law  with  reference  to  corporations;  and  this 
common  law,  for  which  search  must  be  made  through  the 
precedents  of  many  years,  governs  where  it  is  not  super- 
seded.    Corporations  as  forms  of  business  organization, 
however — and  espe^-ially  as  forms  of  organization  for 
relatively  small  enterprises — are  comparatively  modern. 
From  the  very  beginning  the  English  Parliament  and 
the  state  legislatures  of  this  country  have  found  it  ex- 
pedient to  enact  statutes  in  order  to  define  clearly  the 
powers  and  duties  of  corporations.     These  statutes  in 
every  state  are  now  so  explicit  and  comprehensive  as  to 
govern  the  great  mass  of  corporate  activities.     They 
form  the  body  of  statutory  law  with  reference  to  corpo- 
rations.    The  reader  will  find  in  the  volume  on  Com- 
MER»  AL  Law  a  full  exposition  of  the  relations  between 
common  and  statutory  law  and  of  the  manner  in  which 
statutes  of  the  legislature  are  interpreted  by  the  courts. 
For  our  purpose  it  is  enough  to  say  that  the  statute  law 
supersedes  the  common  law  wherever  the  two  disagree 
and  that  statute  law  with  regard  to  corporations  is  so 
voluminous  that  we  need  rarely  go  back  of  it  to  the 
common  law. 

15.  The  state  constitution. — The  fundamental  law  in 
each  state  of  the  ITnion  is  the  constitution  of  the  state, 
and  no  provision  which  conflicts  with  any  clause  in  the 
state  constitution  will  be  legal.  This  is  a  point,  not 
merely  of  theoretical,  but  also  at  times  of  distinct  practi- 
cal importance.  For  instance,  the  Constitution  of  the 
State  of  Pennsylvania  prescribes  that  all  Pennsylvania 
corporations  shall  elect  their  officers  by  what  is  known 
as  "cumulative  voting"— a  method  that  is  described  at 
some  length  in  Chapter  V.     In  one  case,  with  which 


LEGAL  STATUS  OF  THE  CORPORATION        19 

the  writer  happens  to  be  familiar,  certain  stockholders 
of  a  small  Pennsylvania  corporation  planned  to  pass  a 
rule  against  cumulative  voting  and  by  means  of  that  rule 
to  elect  all  members  of  the  board  of  directors.  Great 
was  their  chagrin  and  surprise  when  they  discovered  that 
no  Pennsylvania  corporation  is  competent  to  enforce 
such  a  rule  as  they  proposed.  It  frequently  happens 
that  some  of  the  ordhiary  statute  provisions  of  a  state 
are  found,  when  tested  in  the  courts,  to  be  in  conflict 
with  some  provision  of  the  state  constitution  and  there- 
fore null  and  void.  The  reader,  then,  should  not  forget 
that  behind  every  enactment  of  the  legislature  looms  the 
constitution  of  the  state,  a  fundamental  factor  that 
should  not  be  left  out  of  his  reckoning. 

16.  Method  of  creating  the  corporation.- -The  direct 
legislative  authority  to  create  a  corporation  may  be  given 
in  one  of  two  ways,  by  special  enactment  of  the  legisla- 
ture for  the  benefit  of  this  particular  corporation,  or  by 
a  general  act  which  governs  the  creation  of  all  corpora- 
tions.   Formerly  the  first  named  method  was  miiversal. 
It  proved  itself,  however,  both  inconvenient  and  unfair. 
Authority  to  incorporate  was  granted  arbitrarily  by  the 
legislature  for  certain  enterprises  and  denied  to  others 
equally  deserving.    It  was  necessary  to  have  a  "pull" 
in  order  to  get  the  desired  enactment.     Favoritism  and 
corruption,  coupled  with  unwise  conservatism,  were  the 
natural  results  of  this  method.     It  has  therefore  faUen 
into  disuse  and  is  definitely  prohibited  by  the  constitu- 
tions of  many  states  of  the  Union.    One  rather  conspic- 
uous exception  to  the  general  rule  that  corporations  are 
no  longer  formed  and  managed  under  the  provision  of 
special  enactments  is  the  Bay  State  Gas  Company,  a 
corporation  organized  by  Mr.  J.  Edward  Addicks,  and 
later  controlled,  it  is  understood,  by  Mr.  Thomas  W. 


0  CORPORATION  FINANCE 

Lawson.  This  company  was  gh  en  large  powers  and 
privileges  by  a  special  act  of  tlie  Legislature  of  Dela- 
ware during  the  time  when  Mr.  Addicks  was  reputed 
to  be  the  political  boss  of  the  State. 

The  present-day  method  of  creating  the  corporation 
is  by  complying  with  the  provisions  of  a  general  corpo- 
ration act— in  some  states  called  an  "enabling  act." 
Such  an  act  usually  prescribes  the  general  purposes  for 
which  corporations  may  be  lawfully  formed,  the  chief 
powers  whifli  they  may  possess— such  as  power  to  hold 
property  in   iie  i)arcnt  ar.d  in  other  states,  power  to  hold 
its  own  stocv    power  to  hold  stock  of  other  corporations 
(not  conferred  by  all  states) ,  power  to  borrow  money, 
power  to  do  business  in  other  states,  and  so  on— the  num- 
ber of  incorporators  and  stockholders,  the  manner  and 
lawful  purposes  of  issue  of  capital  stock,  the  rights  of  the 
stockholders,  the  minimum  numbers  of  directors  and  of 
officers,  the  character  and  amount  of  taxes,  the  nature  of 
reports  required,  the  exact  form  to  be  followed  in  incor- 
porating, and  so  on.     Under  such  a  general  act  any 
citizens    of    the    state— sometimes    of    other    states— 
who  meet  the  requirements  of  the  law  may  form  a 
corporation.     Thus  the  favoritism  and  corruption  in- 
cident  to  the   old  method  of  specia'    enactment' are 
eliminated.     The    universal    establishment    of    these 
general  corporation  acts  is  one  of  the  most  important 
reforms  in  business  methods  of  the  second  half  of  the 
nineteenth  century.     Though  many  of  these  acts— as 
is  pointed  out  in  Chapter  IV— are  far  from  perfect,  we 
all  have  reason  to  be  profoundly  thankful  that  they  exist 
at  all. 

17.  Essential  features  of  the  charter.— We  come  now 
to    the    immediate    instrument    of    incorporation,    the 


LEGAL  STATUS  OF  THE  CORPORATION        21 

charter— sometimes  called  the  certificate  of  incorpora- 
tion or  the  articles  of  incorporation.  Where  the  charter 
is  obtained  under  a  general  corporation  act,  it  is  drawn 
by  the  incorporators  or  their  attorney  and  presented  to 
the  proper  state  official,  usually  the  secretary  of  state. 
If  the  charter  as  drawn  is  approved,  the  secretary  of 
state  signifies  his  acceptance  thereof,  and  the  corporation 
comes  into  being.  There  is  no  favoritism  in  this  pro- 
cedure, as  there  is  in  the  granting  of  charters  by  special 
acts;  the  secretary  of  state  has  no  authority  to  refuse 
any  charter  which  is  properly  dra^^Ti  and  which  complies 
with  the  provisions  of  the  state  law. 

A  charter  need  not  be  a  very  lengthy  instrument,  al- 
though large  companies  sometimes  find  it  desirable  to 
prevent  future  misunderstanding  by  inserting  into  the 
charter  a  great  many  details  not  absolutely  essential. 
In  practically  all  states  every  charter  must  contain, 
among  other  things,  the  following  information: 

(1)  The  name  of  the  corporation. 

(2)  The  purpose  or  purposes  for  which  it  is  formed. 

(3)  The  amount  of  capital  stock,  and  if  there  is  a 
division  into  classes  of  stock,  the  rights  of  each  class. 

(4)  The  number  of  shares  of  stock. 

(5)  The  location  of  the  principal  business  office. 

(6)  The  period  of  existence  of  the  corporation,  which 
is  usually  unlimited  or  perpetual. 

(7)  The  names  and  usually  the  post-office  addresses 
of  the  incorporators. 

If  the  reader  desires  "  more  detailed  statement  of  the 
requirements  in  any  ticular  state,  he  cannot  do  better 
than  to  go  direct  to  tlie  statutes  of  that  state.  It  would 
lead  us  too  far  afield  if  we  were  to  enter  here  on  any 
comprehensive  legal  study  of  charter  forms  and  provi- 


22 


CORPORATION  FINANCE 


sions.  A  few  remarks,  liowever,  as  to  the  essential  fea- 
tures of  a  charter  and  the  presentation  of  the  sample 
form  following  will  not  be  out  of  place  and  will  help  to 
make  clear  some  points  of  corporation  practice  that 
might  otherwise  be  obscure. 

18.  A  sample  charter. — The  following  is  a  very  brief 
and  simple  charter,  which  conforms  to  the  laws  of  the 
State  of  New  Jersey.  The  form  in  other  states  would 
be  slightly  different.  The  writer  is  indebted  to  Mr. 
Thomas  Conyngton  for  permission  to  copy  this  form 
from  his  manual  "The  Modern  Corporation." 

CERTIFICATE  OF  INCORPORATION 

OF  THE 

CARIIART  DRUG  COMPANY. 

We,  the  undersigned,  for  the  purpose  of  forming  a  corpora- 
tion under  and  by  virtue  of  tlie  provisions  of  an  act  of  the 
Legislature  of  the  State  of  New  Jersey,  entitled  "  An  Act  con- 
cerning corporations  (Revision  of  1896),"  and  the  sever  sup- 
plements thereto  and  acts  amendatory  thereof,  do  hereby  or- 
ally subscribe  for  and  agree  to  take  the  number  of  shares  of 
stock  of  the  said  corporation  hereinafter  placed  opposite  our 
respective  names,  do  further  certify  and  set  forth  as  foUr    s: 

First — The  name  of  said  corporation  shall  be 

"CARHART  DRUG  COMPANY." 

Second — The  location  of  its  principal  office  in  the  State 
of  New  .Jersey  shall  be  at  No.  1.5  Exchange  Place,  Jersey  City. 

The  name  of  the  agent  who  shall  be  therein  and  in  charge 
thereof,  upon  whom  proce;  s  against  this  Corporation  may  be 
served,  is  the  Corporation  Trust  Company  of  New  Jersey. 

Third — The  objects  for  which  this  corporation  is  formed 
are: 

(a)         To  manufacture,  prepare,  compound,  mix,  com- 
bine, buy,  soli  and  generally  deal  in  all  manner  of 


LEGAL  STATUS  OF  THE  CORPORATION   «3 

cheuncals,  chcn^ical  products,  drugs  and  pharmaceu- 
tical  compounds   and  preparations,   and  to   patent, 
register  or  otherwise  protect  the  same. 
(b)  To  obtain,  purchase  or  otherwise  acquire  form^M 

^^    patents  and  secret  processes  for  the  -nuf actur    an^^^ 
preparation  of  chemicals,  drugs  and  the  compounds 
Ll  preparations  thereof,  and  to  operate  under,  sH 
assign,  grant  licenses  in  respect  of,  or  otherwise  turn 
the  same  to  account. 
(c)         To  enter  into,  carry  out  or  otherwise  turn  to  ac 
^^     count  contracts  of  every  kind;  to  have  and  mamtam 
offices  within  and  without  the  State ;  to.-^-^' ^°^^' 
,„ortgage,  lease  and  convey  or  otherwise  use  or  d^ 
pose  of  real  and  personal  property  m  any  part  of  the 
world;  and  in  general  to  carry  on  such  operations  and 
:„terprises  and  to  do  all  such  things  ,n  connection 
therewith  as  may  be  permitted  by  the  laws  of  New 
Jersey  and  be  necessary  or  convenient  m  the  conduct 
of  the  Company's  business. 
Fourth-The  total  authorized  slock  of  the  corporation  shall 
be  Wy-five  thousand  dollars  ($25,000),  divided  into  two  hu^ 
betwent)  nvt.  Ill  „f  fi,,.  nRr  value  of  one  hundred 

($;),000).  addresses   of  the   incor- 

p:ffU__The  names   and   post-office   adaresses   ui 
,,.,' :1  I;  the  „u,„.,cr  of  shares  subscribed  for  b,  each  are 

as  follows: 

Addresses  Shares 

Wnurrr^hart,  .^  E.c,.„^  Place,  .e.e,  C.,,  N.  3.  « 

Sheldon  McCammis .   "  ^^  ^^         „       „    „      g 

•'t.STp;rlod"of  «l„co  of  said  corporation  .....  b. 
"""tlvitnc^  Whereof,  we  have  hereunto  .t  our  hand,  and 


24  CORPORATION  FINANCE 

seals  this  21st  day  of  July,  A.  D.  nineteen  hundred  and 
eight. 

Wilh's  J.  Carhart.      (L.  S.) 
Sheldon  ^IcCanimis.    (L,  S.) 
John  B.  Whelan.        (L.  S.) 
In  the  presence  of 
Harmon  Watson. 
Thomas  O'Connell. 

(Execution  in  due  form.) 

19.  TJie  corporate  name. — The  name  of  a  corporation 
is  part  of  its  i^roperty  and  sometimes — especially  after 
the  corporation  has  been  long  enough  established  to  have 
acquired  good  will — is  highly  valuable  property.  For 
that  reason,  a  new  corporation  is  not  allowed  to  assume 
a  name  already  taken  by  a  previously  existing  corpora- 
tion nor  even  a  name  so  similar  as  to  cause  confusion. 
If  the  older  corporation,  however,  in  such  a  case  were 
not  incorporated  or  licensed  in  the  same  state  as  the  new 
company,  the  state  authorities  would  have  no  right  to 
reject  the  new  company's  charter  on  account  of  the  sim- 
ilarity in  name.  Under  such  circumstances  the  only 
remedy  of  the  older  company  would  be  to  bring  suit  in 
the  courts.  Some  states  lay  <lown  certain  arbitrary 
rules,  such  as  that  the  prefix  "The  "  must  be  used,  or  that 
the  word  "incorporated"  or  "limited"  must  follow  the 
corporate  name.  Alabama,  Colorado,  Kentucky,  Con- 
necticut, Delaware,  Kansas,  Missouri,  North  Carolina 
and  Virginia  require  the  word  "company"  to  be  a  part 
of  the  corporate  name.  As  a  matter  of  business,  it  is 
usually  ver\'  desirable  for  a  new  corporation  to  adopt 
some  distinctive,  self-explanatory,  short  name,  and  to 
avoid  so  far  as  possible  hackneyed  words  and  phrases. 

20.  The  corporate  purposes. — There  is  no  more  im- 
portant section  of  the  charter  than  that  in  which  the 


A 


LEGAL  STATUS  OF  THE  CORPORATION 


«5 


corporate  purpose  or  purposes  are  stated.    For  most 

Zorations,  the  activities  of  which  are  to  be  confl"ed  to 

s^e  one  Une  of  business,  a  brief  and  simple  statement 

s  aU  that  is  necessary.    The  incorporators  and  their 

.ttorney  should  bear  in  mind  in  this  connection,  however 

L  it 'costs  nothing  at  the  •-g;»"'"«/° 'rfp^JSTe 
full  and  comprehensive  description  of  all  the  possible 
a"  ivities  of  the  corporation  and  that  the  absence  of  the 
Sh    word  or  phrL  may  at  some  future  time  cause 
serious  inconvenience.    The  «,rporat>on  «  "<>»  "bl^g"!  to 
Tarry  out  all  of  the  purposes  named  in  the  charter;  on 
the  oth«-  hand,  it  has  no  authority  to  do  anythmg  which  is 
n:ttnamed  or  clearly  implied.    The  courts,  to  ^sure 
are  sencraily  liberal  in  their  interpretation  of  the  implied 
t«wfrs  of  .iirporations-,  but  it  is  better  to  keep  out  of 
r»urts  and  to  take  a  little  care  at  the  beginning  so 
as  t^^^rt  any  future  disputes  as  to  whether  proposed 
uctivitls  are  beyond  the  purp<»es  and  powers  of  the 

coi'Doration  or  not.  ^r  « 

To  illustrate  the  care  with  which  the  PU^P^^-of  « 
larKC  company  are  stated  in  order  to  comprehend  and 
Zlc^al  authority  for  any  possible  future  a«'v>ty.  he 
fharter  of  the  United  States  Steel  Corporation,  which 
ts  drawn  by  one  of  the  great  -porat'on  awyers  of 
the  country,  the  late  James  B.  Dill,  of  New  Jersey, 
ZlyZ  cite'i    The  section  of  the  charter,  m  which  the 
purposes  of  this  great  corporation  are  stated,  ,s  too  long 
o  l«  quoted  in  full.    Nine  paragraphs  are  devoted  to 
'describing  all  the  manufacturing,  landownmg,  mining. 
tr«ling,  «,ntr«c»ing,  inventing  and  patenting,  security- 
buytog   selling  and  holding  activities  >vbich  could  be 
thought  of  by  »U  the  eminent  lawyers  and  business  men 
who  helped  Judge  Dill  to  draw  the  charter.     Then 
;lw  thftwo  piagrapl.  quoted  below,  in  which.  ., 


\ 


26 


CORPORATION  FINANCE 


the  reader  will  observe,  the  incorporators  aim  to  provide 
for  any  other  possible  actiA'ity  not  already  distinctly  set 
forth.  Note  particularly  the  italicized  clauses.  A  state- 
ment somewhat  similar  to  these  two  paragraphs  might 
be  included  to  advantage  in  the  charters  of  many  much 
smaller  corporations,  and  perhaps  would  dispose  of 
otherwise  troublesome  questions  of  authority. 

The  business  or  purpose  of  the  Company  is  from  time  to  time 
to  do  any  one  or  more  of  the  acts  and  things  herein  set  forth ; 
and  it  may  conduct  its  business  in  other  States  and  in  the  Terri- 
tories and  in  foreign  countries,  and  may  have  one  office  or  more 
than  one  office,  and  keep  the  books  of  the  company  outside  the 
State  of  New  Jersey,  except  as  otherwise  may  be  provided  by 
law;  and  may  liold,  purchase,  mortgage  and  convey  real  and 
personal  property  either  in  or  out  of  the  State  of  New  Jersey. 

Witliout  in  any  particular  limiting  any  of  the  objects  and 
powers  of  the  corporation,  it  is  hereby  expressly  declared  and 
provided  that  the  corporation  shall  have  power  to  issue  bonds 
and  other  obligations  in  payment  for  property  purchased  or  ac- 
quired by  it,  or  for  any  other  object  in  or  about  its  business; 
to  mortgage,  or  pledge  any  stocks,  bonds,  or  other  obliga- 
tions, or  any  property  which  may  be  acquired  by  it,  to  secure 
any  bonds  or  other  obligations  by  it  issued  or  incurred;  to  guar- 
antee any  dividends  or  bonds  or  contracts  or  other  obligations; 
to  make  and  perform  contracts  of  any  kind  and  description ;  and 
in  carrying  on  its  business,  or  for  the  purpose  of  attaining  or 
furthering  any  of  its  objects,  to  do  any  and  all  other  acts,  and 
things,  and  to  exercise  any  and  all  other  powers  which  a  co- 
partnership or  natural  person  could  do  and  exercise,  and  which 
now  or  hereafter  may  he  authorized  by  law. 

A  further  illustration  of  the  importance  of  a  clear  and 
full  statement  in  the  charter  of  the  purposes  for  which  a 
corporation  is  organized  is  contained  in  a  decision  of  the 
New  Jersey  Court  of  Errors  and  Appeals  handed  doivn 
March  5,  1909.     The  case  involved  the  right  of  a  rail- 


LEGAL  STATUS  OF  THE  CORPORATION 


27 


road  company  to  acquire  -d  hold  the  s-J^ckof^  certain 
trolley  companies  near  Atlantic  City.  J''l^°^ 
S  this  right  and  said,  among  other  thmgs. 

Xhe  peer  to  pure„a,e  hold,  etc    stock  and^^^^fj^^ 

e„rp„»«o„s  '""'^'^^y^X'^^^LZZ^^y  Sec- 
act  is  to  be  exerci^d  suHject  to  the  nm  ^ 
f,„„  «  of  the  same  act ;  that  «  to  say,  the  po«r  ^ 

vonient  to  the  attainment  of  the  objects  »«»«;"  ^^^^^ 
charter  or  certificate  of  i-'P""""".  '  J  "^^^'ey  GenenJ 
to  the  certi«cate  of  --7™*'?  .^ff  ^  ptopi  cL  readily 
and  other  offlcials  interested  on  ^^^alf  of^te  peop  ^^ 

determine  »hat  powers  have  ^2,^^^ti  by  the  state.    It 

.ompany  is  -7';«/™t:f  alS™  th'at  investors  can 
«  by  reference  to  the  a*cks  ol  _^_^^^^^_^^  .__^__  ,^.^^ 

r;tt rSta  t  pCrty  rights  they  are  acuiring  in 

.■-•--■"f'tLlorlttenC' stock  ownership  by  on.  corn- 
It  must  not  be  f"lf »™ J  ^^-^^  the  former  company 
pany  in  another  .s  ""'^  »  """^J  "j^t  .;„«  the  second  com- 

^''"^^"sttiorrw    e*n^  L  in  iU  effert)  might  Ki-e. 
puny  (If  Section  51  ""'  "  ■»  ti„„  „  corporation.,  and 

wise  hold  stock  m  any  other  ™"Tor«t.o  J  . 

"-"  -g-t  ao  *-- 1:      rttlnceapartlipation 
company  under  such  a  system  woui  participation  in  a 

in -^  ■'-"tr -''"^f  rr:;^:- sti'.'rrL'maiority. 

"blind  pool"  subject  to  the  uncon  ^  ^. 

There  would  be  an  end  at  once  of  aU  P»^'f  ^;^^„  ,^  ,t.t, 

trine  that  '^'-'^"'^^'•1:^:^:^^:^ ^  ^^^^« 

und  the  corporation  or  between  tne  corp 
themselves. 

Evidently  the  eminent  ,awj-er,  who  d«w  up^ 
d^r,  or  certificate  of  incorporation,  of  the  railro«l 


28 


CORPORATION  FINANCE 


company  in  this  instance  were  either  careless  or  lacking 
in  foresight.  Otherwise,  they  would  have  avoided  this 
adverse  decision  very  easily  by  including  among  the 
powers  granted  by  the  charter  the  right  to  acquire  and 
hold  stock. 

21.  Other  important  features  of  the  charter, — The 
amount  of  capital  and  the  number  of  shares  of  a  new 
corporation  which  are  desirable  depend  on  principles  of 
capitalization  that  are  discussed  in  Chapter  VII  and 
which  need  not  be  considered  at  this  stage. 

Most,  though  not  all,  of  the  state  laws  require  that  the 
principal  office  of  the  corporation  shall  be  within  the  state 
where  the  charter  is  secured.  Partly  for  this  reason, 
other  things  being  equal,  it  is  better  to  secure  a  charter 
from  that  state  in  which  most  of  the  business  of  a  corpo- 
ration is  carried  on;  but  this  is  by  no  means  an  invariable 
rule,  as  will  be  pointed  out  in  Chapter  IV.  It  is  also 
usual,  although  not  universal,  to  provide  that  one  or 
more  of  the  incorporators  shall  be  citizens  of  the  state 
which  grants  the  charter.  The  minimum  number  of  in- 
corporators in  most  states  is  three. 

The  number  of  directors  of  a  new  corporation  is  an 
important  point  to  consider  when  the  charter  is  obtained. 
Sometimes  the  nimiber  is  stated  not  in  the  charter,  but  in 
the  by-laws  and  may  readily  be  amended  from  time  to 
time;  but  where  the  number  is  fixed  by  the  charter  it 
cannot  be  easily  changed.  A  small  board  obviously  is 
apt  to  be  more  efficient  than  a  large  board.  This  is 
another  question  which  will  come  up  for  fuller  discussion 
in  a  subsequent  chapter. 

22.  The  by-laws. — The  by-laws  are  simply  a  collec- 
tion of  permanent  rules  for  transacting  business  adopted 
by  the  stockholders  or  directors.  It  is  not  absolutely 
necessary,  though  almost  always  very  desirable,  that  a 


LEGAL  STATUS  OF  THE  CORPORATION 


29 


corporation  should  have  by-laws.    The  by-laws  usuaUy 
contain  provisions  as  to: 

(1)   Issue  and  transfer  of  stock. 

2  Meetings  of  stockholders  and  directors. 

3  Election  of  directors  and  officers. 

4  Powers  and  duties  of  directors  and  officers 

(5)  General  directions  as  to  the  management  of  the 

"ri^^Xlfo'f  the  charter,  we  will  run  over  hriefly 

a  irsx,  iiic  *^»  ,        ^      York  corporation, 

«pt  of  bv-laws,  which  is  used  by  a  iN  ew  x  or^       t- 

cellent  manual,  "The  Modern  Corporation. 

BY-LAWS 

OF  THE 

STANDARD  BLEACHING  COMPANY, 

NEW  YORK  CITY 

Article  I. — Stock. 
1.  Certiflcte.  of  Stock  shaU  be  i.ued  in  m.^nc.1  order  from 

urcr  and  sealed  by  the  Secret    ,  ^^^^j 

.cord  of  each  -^.S-^V^^  ^1^,":^  „p„n  the  books  of 
Jc^rana  br  a  ne.  eerti«»te  U  issued  the  .do. 

;.  ;7!:dl'::sta:din.  sto*  of  the  company  J  ™^  ^.-Jd 

"-''-''"»5°™7,V*:~^°"       such    stock 

subject  to  disposal  by  the  uoar 


^,>-i 


30 


CORPORATION  FINANCE 


1 


I 


w' 


shall  neither  vote  nor  participate  in  dividends  while  held  by  the 
Company. 

Article  II. — Stockholders. 

1.  The  Annual  Meeting  of  the  stockholders  of  this  Company 
shall  be  held  in  the  principal  office  of  the  Company  in  New 
York  City  at  12  M.  on  the  second  Monday  in  January  of  each 
year,  if  not  a  legal  holiday,  but  if  a  legal  holiday  then  on  the 
day  following. 

2.  Special  Meetings  of  the  stockholders  may  be  called  at  the 
principal  office  of  the  Company  at  any  time  by  resolution  of  the 
Board  of  Directors,  or  upon  written  request  of  stockholders 
holding  one-third  of  the  outstanding  stock. 

3.  Notice  of  Meetings,  written  or  printed,  for  every  regular 
or  special  meeting  of  the  stockholders,  shall  be  prepared  and 
mailed  to  the  last  known  post-office  address  of  each  stockholder 
not  less  than  ten  days  before  any  such  meeting,  and  if  for  a 
special  meeting,  such  notice  shall  state  the  object  or  objects 
thereof.  No  failure  or  irregularity  of  notice  of  any  regular 
meeting  shall  invalidate  such  meeting  or  any  proceeding 
thereat. 

4.  A  Quorum  at  any  meeting  of  the  stockholders  shall  con- 
sist of  a  majority  of  the  voting  stock  of  the  Company,  repre- 
sented in  person  or  by  proxy.  A  majority  of  such  quorum  shall 
decide  any  question  that  may  come  before  the  meeting. 

5.  The  election  of  Directors  shall  be  held  at  the  annual  meet- 
ing of  stockholders  and  shall,  after  the  first  election,  be  con- 
ducted by  two  inspectors  of  election  appointed  by  the  Presi- 
dent for  that  purpose.  The  election  shall  be  by  ballot,  and 
each  stockholder  of  record  shall  be  entitled  to  cast  one  vote  for 
each  share  of  stock  held  by  him. 

6.  The  Order  of  Business  at  the  annual  meeting,  and,  as  far 
as  possible,  at  all  other  meetings  of  the  stockholders,  shall  be : 

1.  Calling  of  Roll. 

2.  Proof  of  due  notice  of  Mcctino-. 

3.  Reading  and  disposal  of  any  unapproved  Minutes. 

4.  Annual  Reports  of  Officers  and  Committees. 


LEGAL  STATUS  OF  THE  CORPORATION 


31 


5.  Election  of  Directors. 

6.  Unfinished  Business. 

7.  New  Business. 

8.  Adjournment. 

Article  III.— Directors. 
1.  The  Business  and  Property  of  the  Company  shall  be  man- 
aged by  a  Board  of  seven  Directors,  who  shall  be  «tockho  ders 
and  who  shall  be  elected  annually  by  ballot  by  the  s  ockholaers 
ZtL  term  of  one  year,  and  shall  serve  untd  the  election  and 
eptance  of  their  duly  qualified  successors.  Any  —e^ 
may  be  filled  by  the  Board  for  the  unexpired  term.  Directors 
shall  receive  no  compensation  for  their  services. 

8    Th    Regular  Meetings  of  the  Board  of  Directors  shall 
be  held  in  the  principal  office  of  the  Company  in  New  York 
Tit V  at  3  P  M   on  the  third  Tuesday  of  each  month,  if  not  a 
W  1  hoi  d!y,    ut  if  a  legal  holiday,  then  on  the  day  foUowuig^ 
3    Special  Meetings  of  the  Board  of  Directors  to  be  held  in 
the  p»  office  o'f  the  Company  in  New  York  City  may  be 
Jled  at  any  time  by  the  President,  or  by  any  ^^^.^^^^^^^^ 
the  Board,  or  may  be  held  at  any  time  and  place,  without  notice 
ly  unanimous  written  consent  of  all  the  members,  or  with  the 
nresence  of  all  members  at  such  mcetmgs.  .    „  i. 

T  Notices  of  both  regular  and  special  meetmgs  sha  1  be 
mid  by  the  secretary  to  each  member  of  the  Board  not  les 
Zn  five  days  before  any  such  meeting,  and  not.ces  of  spec,al 
melngs  shall  state  the  purposes  thereof.  «»  -lu- or -gu- 
Urity  of  notice  of  any  regular  meetmg  shaU  mval.date  such 
meetinir  or  any  proceeding  thereat. 

7  A  Quorum  at  any  meeting  shall  consist  of  »  .™aJor,ty  ot 
the  entire  membership  of  the  Board.  A  majorrty  of  sud^ 
Quorum  shall  decide  any  question  that  may  come  before  the 

■"t"  Mcers  of  the  Company  shall  be  elected  by  ballot  by  the 
Board  of  Directors  at  their  first  m«ti„g  after  the  ele*on  o 
directors  each  year.     If  any  offlee  becomes  '-""'/"""^^ 
year,  the  Board  of  Directors  shall  fill  the  same  for  the  unex 


32 


CORPORATION  FINANCE 


if 


1 


pircd  term.     The  Board  of  Directors  shall  fix  the  compensa- 
tion of  the  officers  and  agents  of  the  Company. 

7.  The  order  of  business  at  any  regular  or  special  meeting 
of  the  Board  of  Directors  shall  be : 

1.  Reading  and  disposal  of  any  unapproved  Minutes. 

2.  Reports  of  Officers  and  Committeet. 

3.  Unfinished  Business. 

4.  New  Business, 
6.  Adjournment. 

Article  IV. — Officers. 

1.  The  Officers  of  the  Company  shall  be  a  President,  a  Vice- 
President,  a  Secretary  and  a  Treasurer,  who  shall  be  elected 
for  one  year  and  shall  hold  office  until  their  successors  are 
elected  and  qualify.  The  positions  of  Secretary  and  Treasurer 
may  be  united  in  one  person. 

2.  The  President  shall  preside  at  all  meetings,  shall  have  gen- 
eral supervision  of  the  affairs  of  the  Company,  shall  sign  or 
countersign  all  certificates,  contracts  and  other  instruments  of 
the  Company  as  authorized  by  the  Board  of  Directors;  shall 
make  reports  to  the  directors  and  stockholders  and  perform  all 
such  other  duties  as  are  incident  to  his  office  or  are  properly  re- 
quired of  him  by  the  Board  of  Directors.  In  the  absence  or 
disability  of  the  President,  the  Vice-President  shall  exercise  all 
his  functions. 

3.  The  Secretary  shall  issue  notices  for  all  meetings,  shall 
keep  their  minutes,  shall  have  charge  of  the  seal  and  the  cor- 
porate books,  shall  sign  with  the  President  such  instruments  as 
require  such  signature,  and  shall  make  such  reports  and  per- 
form such  other  duties  as  are  incident  to  his  office,  or  are  prop- 
erly required  of  him  by  the  Board  of  Directors. 

4.  The  Treasurer  shall  have  the  custody  of  all  moneys  and 
securities  of  the  Company  and  shall  keep  regular  books  of  ac- 
count and  balance  the  same  each  month.  He  shall  sign  or  coun- 
tersign such  instruments  as  require  his  signature,  shall  perform 
all  duties  incident  to  his  office  or  that  are  properly  required  of 
him  by  the  Board,  and  shall  give  bond  for  the  faithful  perform- 


LEGAL  STATUS  OF  THE  CORPORATION        33 

ance  of  his  duties  in  such  sum  and  with  such  sureties  as  may  be 
required  by  the  Board  of  Directors. 

Article  V. — Dividends  and  Finance. 

1.  Dividends  shall  he  declared  only  from  the  surplus  profits  at 
such  times  as  the  Board  of  Directors  shall  direct,  and  no  divi- 
dend shall  be  declared  that  will  impair  the  capital  of  the  Com- 
pany. 

2.  The  moneys  of  the  Company  shall  be  deposited  in  the  name 
of  the  Company  in  such  bank  or  trust  company  as  the  Board  of 
Directors  shall  designate,  and  shall  be  drawn  out  only  by  check 
signed  by  the  Treasurer  and  countersigned  by  the  President. 

Article  VI.— Seal. 

1.  The  Corporate  Seal  of  the  Company  shall  consist  of  two 
concentric  circles,  between  which  is  the  name  of  the  Company, 
and  in  the  centre  shall  be  inscribed  "Incorporated  1905,  New 
York,"  and  such  seal,  as  impressed  on  the  margin  hereof,  is 
hereby  adopted  as  the  Corporate  Seal  of  the  Company. 
Article  VII. — Amendments. 

1  These  By-Laws  may  be  amended,  repealed  or  altered,  in 
whole  or  in  part,  by  a  majority  vote  of  the  entire  outstandmg 
stock  of  the  Company,  at  any  regular  meeting  of  the  stock- 
holders, or  at  any  special  meeting  where  such  action  has  been 
announced  in  the  call  and  notice  of  such  meeting. 

2.  The  Board  of  Directors  y  adopt  additional  by-laws  in 
harmony  therewith,  but  shall  not  alter  nor  repeal  any  by-laws 
adopted  by  the  stockholders  of  the  Company. 

23.  Essential  features  of  the  hy-laws.—The  sections 
with  regard  to  stock  are  usually  of  a  formal  character 
and  state  simply  that  the  ownership  of  stock  shall  be 
evidenced  by  the  issue  of  certificates  to  each  stockholder, 
and  that  transfers  of  ownership  shall  be  made  only  upon 
the  books  of  the  company.  The  reader  should  thor- 
oughly understand  this  provision,  which  is  prarticaUy 
universal.  Pyrequently  the  engraved  certificate  of  stock 
r—vi— 3 


34 


CORPORATION    FINANCE 


in  the  possession  of  a  stockholder,  which  usually  reads 
This  is  to  certify  that  John  Doe  is  the  owner  of 
shares  of  the  capital  stock  of  the  John  Doe  Company* 
transferable  only  on  the  books  of  the  company,  etc  '' 
(see  page  96)   is  incorrectly  called  and  mistaken  for 
stock  Itself.    As  a  matter  of  fact,  stock  is  an  intangible 
thing;  It  is  merely  a  right  to  a  share  in  the  company's 
assets  and  earnings.    A  certificate  is  only  a  convenient 
method  of  proving  that  a  certain  person  is  the  owner  of 
stock.    A  certificate  may  be  lost  or  stolen  or  given  away 
or  sold  and  yet  the  ownership  of  the  stock  will  remain 
unchanged.    Only  by  transfer  on  the  books  of  the  com- 
pany will  a  change  in  ownership  be  consummated.    The 
usual  method  of  transferring  stock  is  to  sign  a  blank 
form  on  the  back  of  each  certificate  (see  page  86)  which 
authorizes  the  secretary  of  the  corporation  or  some  other 
agent  of  the  owner  to  make  the  transfer. 

The  by-laws  almost  always  specify  the  time  and  place 
of  an  annual  m-eting  of  stockholders  for  the  transaction 
of  important  business.     Special  meetings  may  be  called 
trom  time  to  time  on  request  of  a  certain  number  of 
stockholders  or  in  whatever  manner  the  by-laws  may 
lay  down.     The  important  point  is  that  to  make  a  special 
meeting  legal  every  stockholder  must  have  proper  notice 
m  writing  mailed  to  his  last-known  address.     Meetings 
of  the  directors  also  are  usually  re(iuired  at  stated  inter- 
vals and  it  is  set  forth  in  the  by-laws  that  the  directors 
are  to  elect  the  officers  of  the  company  and  otherwise  to 
manage  its  affairs. 

The  essential  officers  of  a  corporation  are  the  presi- 
dent, the  secretary  and  the  treasurer.  The  duties  of 
each  officer  should  lie  and  usually  are  clearly  specified 
in  the  by-laws.  Ordinarily  the  president,  brieflv  stated, 
IS  the  chief  executive  officer;  the  secretary  keeps  the 


LEGAL  STAT0S  OF  THE  CORPORATION   35 

records  of  the  corporation;  the  treasurer  handles  the 
corporate  funds.  The  reader  should  clearly  understand, 
however,  that  this  definition  of  duties  is  not  necessarily 
or  universally  followed.  The  by-laws  may  make  the 
president  the  custodian  of  funds  and  the  treasurer  the 
chief  executive  officer,  or  may  distribute  the  duties  in  any 
other  manner.  The  law  recognizes,  however,  that  an 
outsider  has  the  right  to  assume  that  the  man  who 
is  given  the  title  of  president,  treasurer  or  secretary  is 
given  the  powers  and  duties  that  customarily  belong  to 
that  position. 

The  by-laws  usually  declare  that  dividends  shall  be 
paid  only  out  of  surplus,  not  out  of  the  capital  of  the 
corp'  dtion,  although  this  is  simply  a  formal  statement 
of  a  principle  which  could  not  legally  be  violated  in 
any  case  so  long  as  the  corporation  has  creditors.  A 
corporate  seal  is  usually  adopted  and  briefly  described 
in  the  by-laws.  The  procedure  and  necessary  percent- 
age of  favorable  votes  in  order  to  amend  the  by-laws 
are  usually  stated. 

The  board  of  directors  or  the  stockholders  may  some- 
times adopt  new  rules  of  action  which  will  be  binding 
until  rescinded,  without  the  formality  of  amending  the 
by-laws,  simply  by  passing  a  formal  resolution.  No 
resolution,  it  need  scarcely  be  said,  will  be  legally  bind- 
ing if  it  is  contrary  to  any  by-law  provision.  Resolu- 
tions are  frequently  used,  however,  to  supplement  and 
further  elucidate  the  by-laws  and  to  lay  down  a  general 
permanent  policy. 

We  have  now  covered  very  briefly  the  main  points 
that  the  reader  should  bear  in  mind  as  to  the  legal  status 
of  the  corporation  and  as  to  the  instruments  that  confer 
and  define  that  status.  All  this  is  rather  dry  and 
more  or  less  technical  matter;  yet  it  must  not  be  slurred 


36 


CORPORATION  FINANCE 


over  by  anyone  who  desires  to  acquire  that  knowledge 
of  the  corporate  form  and  understanding  of  its  uses  and 
misuses  that  is  essential  to  every  person  successfully 
concerned  with  modern  business.  We  cannot  afford  to 
forget  that  the  corporation  is  created  and  maintained 
under  certain  specific  provisions  of  the  law  to  which  all 
its  actions  must  conform. 


CHAPTER  III 

INTERIOR  ORGANIZATION 

24.  Rights  of  Stockholders.— In  this  chapter  we  shall 
treat  as  briefly  as  the  subject  will  permit  the  relations 
to  each  other  of  the  various  groups  of  individuals  who 
are  interested  in  a  corporation.    Those  groups  are: 

I.  Stockholders. 
II.  Creditors. 

III.  Directors. 

IV.  Officers. 

Every  corporation  must  be  so  organized  that  the  duties, 
the  liabiUties  and  the  rights  of  each  of  these  groups  are 
clearly  known  and  may  be  enforced. 

The  nature  of  stock— the  fact  that  it  is  an  intangible 
share  in  the  corporation's  assets  and  earnings— has  al- 
ready been  discussed.     Each  owner  of  stock  becomes  to 
the  extent  of  his  holdings  an  owner  of  the  corporation. 
His  rights  fundamentally  are  the  same  as  the  rights  of 
other  owners  of  private  property,  but  the  full  exercise 
of  these  rights  is  under  the  corporate   form  much 
abridged  and  modified.    To  illustrate,  the  private  owner 
of  a  piece  of  property  has  the  right  to  sell  or  destroy  or 
give  away  or  use  for  his  personal  enjoyment  the  prop- 
erty and  its  earnings.     A  stockholder,  however,  cannot 
sell  or  destroy  or  otherwise  tamper  with  his  proportion 
of  the  corporation's  assets,  because  under  the  corporate 
lorm  he  has  committed  those  assets  to  the  care  of  other 
oeople. 

87 


38 


CORPORATION  FINANCE 


The  rights  of  stockholders  as  a  lx)dy  are: 

(1)  To  elect  directors. 

(2)  To  amend  the  charter  or  by-laws. 

(3)  To  sanction  or  veto  the  selling  or  mortgaging  of 
the  permanent  assets  of  the  corporation. 

(4)  To  dissolve  the  company. 

The  first  two  rights  have  been  touched  upon  in  the 
preceding  chapter  and  need  not  be  further  considered. 
The  third  right  is  not   universal  in  all  states  and  under 
all  charters,  but  is  generally  conceded.     In  some  states 
the  courts  assume  that  the  stockliolders,  having  chosen 
directors,  freely  turn  over  to  them  the  sole  and  complete 
management  of  the  business  without  any  reservations 
whatsoever.     Even  in  such  states,  however,  the  directors, 
in  order  to  avoid  any  charge  of  fraud  that  might  be 
brought  against  them,  generally  prefer  on  such  impor- 
tant actions  as  the  sale  of  permanent  assets  to  have  the 
officially  expressed  concurrence  of  the  stockholders.     A 
clause  is  sometimes  placed  either  in  the  charter  or  in  the 
by-laws  requiring  unanimous  consent  or  the  consent  of 
a  very  large  percentage  of  the  stockholders  in  order  to 
validate  a  sale  or  mortgage  of  permanent  assets.     The 
right  of  dissolution  is  very  seldom  exercised  inasmuch 
as  an  unsuccessful  corporation  may  be  very  easily  aban- 
doned and  its  charter  allowed  to  lapse  by  non-payment 
of  taxes. 

25.  The  proxy  and  its  uses.— The  rights  of  each  in- 
dividual stockholder  are  four  in  numl)er,  as  follows: 

(1)  To  receive  notice  of  and  to  participate  in  all 
stockholders'  meetings. 

(2)  To  share  in  the  assets  of  the  corporation  in  pro- 
portion to  his  stockholdings  in  case  of  dissolution. 

(8)   To  share  in  dividends  declared  by  the  directors 
in  proportion  to  his  stockholdings. 


INTERIOR  ORGANIZATION 


39 


(4)  To  inspect  the  accounts  of  the  corporation. 

The  first  right  has  already  been  mentioned.  It  should 
be  further  observed,  however,  that  a  stockholder's  right 
to  participate  in  meetings  is  not  confined  to  personal 
attendance  at  the  meetings.  If  he  does  not  go  himself 
he  may  confer  the  right  to  represent  him  upon  some 
other  person.  The  instrument  which  confers  this  right 
is  known  as  a  "proxy"  and  generally  reads  somewhat  as 
follows: 

KNOW  ALL  MEN  BY  THESE  PRESENTS,  that  I,  the 
undersigned,  do  hereby  constitute  and  appoint  John  Doe  my 
true  and  legal  attorney  to  represent  nic  at  all  meetings  of  the 
stockholders  of  tlie  Blank  Company  and  for  me  and  in  my 
name  and  stead  to  vote  throughout  upon  the  stock  standing 
in  my  name  on  the  books  of  said  company  at  the  times  of 
said  meetings,  and  I  hereby  grant  my  said  attorney  all  the 
powers  that  I  should  possess  if  personally  present. 

This  is  a  form  well  adapted  to  conferring  a  simple,  un- 
limited right  to  represent  the  stockholder  who  gives  it. 
The  proxy  may  be  much  more  formal  and  may  contain 
any  limitations  that  the  giver  chooses  to  impose ;  for  in- 
stance, it  may  be  good  only  for  one  meeting  or  up  to  a 
certain  time  or  for  a  certain  purpose,  such  as  giving  an 
affirmative  vote  on  a  proposition  that  is  to  come  before 
the  meeting. 

The  use  of  proxies  in  this  country  is  widespread  and 
is  an  important  feature  of  corporation  management. 
In  England  stockholders  are  more  likely  to  appear  in 
person  at  the  annual  meetings.  By  means  of  proxies 
American  corjx)ration  officials  are  accustomed  to  hold 
meetings  with  no  one  but  themselves  actually  attending, 
but  with  a  constructive  attendance  through  their  proxies 
of  more  than  a  majority  of  the  outstanding  stock.    The 


40 


CORPORATION  FINANCE 


i'l 


Union  Pacific  Railroad,  for  instanc^e,  which  is  incorpc 
rated  m  Utah  and  must  hold  its  annual  meetings  in  that 
state,  whereas  its  principal  office  is  in  New  York  City 
every  year  sends  its  secretary  and  a  few  minor  officios 
from  New  i  ork  to  Salt  Lake  City,  each  official  carrying 
.satchel  full  of  proxies.  The  annual  meeting  is  then 
held  and  the  election  of  directors  carried  out  with  all  the 
formality  that  would  characterize  a  fully  attended  meet- 

fi!S  tl,  rr         ^'•^■^•'"W"  »''o  appears  in  person  wiU 
find  that  his  presence  adds  nothing  to  the  effectiveness 

in  tt  I^T'ni'^'  ""•'  'Z""^"  "»'  •^^I'onse  their  character 
in  the  least.  Of  course,  m  smaller  companies  the  stock- 
holders are  more  likely  to  be  present  in  person,  although 
even  Uiere  representation  by  proxy  is  the  estabUshrf 

the°^tn^'"<>*  '*""'  '  T^y  *''  »'«'"''>  ^  '■■"P'^^ed  on 
the  mmd  of  every  stockholder  is  that  it  is  n«-er  under 

any  circumstances  irrevocable.  The  courts  will  not  rec- 
ognize an  irrevocable  proxy  as  a  valid  agreemen"  No 
matter  what  the  wording  of  the  original  p™"ymay  W^ 
no  matter  rf  ,t  clearly  and  emphatically  sLes  thlt  it  is 
.mvocable,  a  stockholder  may.  as  a  milter  of  fac  and 
of  law.  revoke  it  at  his  will. 

tJ.^  T"^  "*'!*'  " '"'  "'■•^"'y  ^"  intimated,  is  in- 
frequently of  much  practical  importance 

26.  The  right  to  dividcmh.—'Fbe  third   riitht_tn 
«h.re  m  dividends-is  so  often  misunderst^  by  sLk" 

J^  trs^r* " "'""'"°"' "«"  f "« --fuii/^ireS. 

In  the  first  place,  notice  that  nothing  is  said  as  to  earn- 

nTflf  """P"™"""  "^y  ^  Betting  enormous  yearly 
profits  and  yet  an  individual  stockholder  may  not  draw 
any  dividend,  whatever;  nor  can  the  stockholder  gt.T 
these  earning,  until  dividends  are  declare,!.  In  the 
second  place,  it  will  be  pointed  out  in  connection  with  Z 


INTERIOR  ORGANIZATION 


41 


powers  of  directors  that  directors  alone  have  the  right 
to  declare  dividends  and  cannot  be  compelled  by  any 
legal  action  whatever  to  grant  dividends  to  the  stock- 
holders until  they  see  fit.  A  case  in  point,  which  at- 
tracted some  attention  several  years  ago,  was  that  of  the 
Midvale  Steel  Company,  a  fairly  large  and  now  pros- 
l)erous  company,  located  in  a  suburb  of  Philadelphia. 
The  management  of  the  company  for  the  ten  years  1887 
to  1897  devoted  all  of  its  earnings  to  improvement  of 
the  plant,  in  spite  of  protests  and  strenuous  efforts  on 
the  part  of  minority  stockholders  to  force  the  declaration 
of  dividends.  The  courts  will  not  interfere  with  the 
policy  of  the  board  of  directors  in  this  regard  unless 
fraud  or  mismanagement  can  be  proved. 

27.  The  right  to  information. — The  fourth  right— to 
inspect  the  corporate  books  and  accounts — was  originally 
universally  admitted  and  was  of  considerable  impor- 
tance. Each  stockholder  could  go  into  the  company's 
office  whenever  he  chose  and  demand  that  he  be  given 
access  to  all  the  books  and  accounts.  Early  in  the  his- 
tory of  business  corporations,  however,  it  became  evident 
that  the  manager  of  a  rival  business  could  buy  a  single 
share  of  stock  and  thereby  obtain  trade  information  that 
could  be  used  to  the  detriment  of  the  corporation.  Thus 
the  anomaly  was  presented  of  a  stockholder  of  a  corpo- 
ration Ixiing  able  t'^-  work  against  the  corporation's  in- 
terests. The  couiis,  recognizing  the  situation,  have 
greatly  modified  and  almost  nullified  this  original  right. 
Xo  stockholder  can  now  on  legal  grounds  demand  that 
he  l)e  furnished  with  information  as  to  the  customers  of 
the  corporation,  the  persons  from  whom  supplies  are 
lM)ught  and  their  prices,  the  corporation's  contracts,  and 
other  points  of  similar  nature.  In  most  states  he  gets 
all  the  information  that  rightfully  l)elongs  to  him  if  he 


<^ 


42 


CORPORATION  FINANCE 


i 


'Jt 


obtains  simply  a  summary  of  the  profit  and  loss  account 
ior  the  preceding  year  and  of  the  balance  sheet  at  the 
end  of  the  corporation's  fiscal  year.  Indeed,  he  cannot 
in  all  states  secure  cn  en  this  meagre  and  apparently  in- 
nocuous mformation. 

The  movement  in  favor  of  publicity  of  corporate  ac 
counts  however,  is  now  so  general  and  strong,  and  the 
force  of  public  opinion  behind  it  is  so  great,  that  ahnost 
all  the  important  corporations  voluntarily  give  to  their 
stockholders  and  to  the  public  fairly  complete  amiual 
reports.     Railroads  particularly  under  the  Interstate 
Commerce  Act,  as  amended  in  1906.  are  compelled  to 
render  to  the  Interstate  Commerce  Commission  and 
through  the  Commission  to  the  public  and  to  their  stock- 
holders, a  very  complete  and  detailed  summary  of  their 
operations  each  year.     One  striking  exception  among 
the  large  corporations  to  this  general  tendency  toward 
increased  pubhcity  is  the  Standard  Oil  Company,  whose 
management  has  never  yet  given  out  anything  more  than 
a  bare  statement  of  the  amount  of  the  capitalization  and 
of  the  dividends  declared.     Publicity  of  accounts  is  not 
to  be  confused  with  the  right  of  the  individual  stock- 
holder to  have  access  to  the  corporation's  books,  for  even 
the  greatest  degree  of  publicity  extends  only  to  general 
financial  results  of  the  corporation's  activities,  not  to  the 
corporation  s  individual  purchases,  sales  and  contracts. 
Ihe  right  to  actual  inspection  of  the  books,  with  few 
unimportant  exceptions,  is  entirely  a  theoretical,  not  a 
practically  important,  attribute  of  stockholders 

28  Liabilities  of  stochhoIders.-The  next  topic  to 
consider  is  that  of  liabilities  of  stockholders,  which  may 
be  grouped  under  the  following  four  heads : 

(1)   Their  liability  to  the  corporation  or  to  unsatisfied 


INTERIOR  ORGANIZATION 


43 


cieditors  of  the  corporation  for  unpaid  installments  on 
part-paid  stock. 

(2)  Their  liability  to  unsatisfied  creditors  of  the 
corporation  in  case  dividends  have  been  paid  out  of 
capital  assets. 

(3)  In  New  York  State,  their  liability  to  employees 
and  servants  for  wages  due  by  the  corporation. 

(4)  In  the  state  of  Minnesota,  their  liability  (except 
manufacturing  corporations)  to  corporate  creditors  up 
to  an  amount  equal  to  the  face  value  of  their  stock- 
holdings.   In  national  banks  the  same  rule  holds  good. 

(5)  In  California  the  unlimited  liability  of  each 
stockholder  for  his  proportion  of  unpaid  obligations  in- 
curred while  he  remained  a  stockholder  of  record.  This 
liability  continues  even  though  he  sells  his  stock. 

With  further  reference  to  the  liability  first  stated  in 
the  preceding  paragraph,  it  should  be  observed  that  cor- 
porations frequently  do  not  need  at  the  beginning  of 
their  existence  all  the  capital  assets  that  will  later  be 
necessary.  They  therefore  ask  their  stockholders  to  pay 
only  a  certain  percentage  of  their  stock  subscriptions  at 
the  beginning  and  either  set  certain  dates  for  the  re- 
maining payments  or  leave  the  dates  to  be  fixed  later  by 
the  directors  of  the  company.  In  the  latter  case  it 
sometimes  happens  that  the  corporation  becomes  so  pros- 
perous that  the  unpaid  installments  are  not  called  for 
and  in  the  course  of  years  stockholders  may  almost 
forget  that  they  are  still  unpaid.  Then  if  the  corpora- 
tion later  gets  into  financial  difiiculties,  the  owners  of 
stock  at  the  time  mav  suddenly  find  themselves  con- 
fronted  by  a  demand  for  the  immediate  payment  of  un- 
paid installments.  It  is  a  very  unpleasant  and  not 
especially  uncommon  situation.    Ttuyers  of  stock  should 


44 


CORPORATION  FINANCE 


i  :: 


therefore  be  very  certain  that  their  certificates  are 
marked  "full  paid  and  non-assessable,"  or  else  make 
sure  that  they  can  meet  whatever  installments  are  un- 
paid, when  called  for,  without  great  inconvenience  to 
themselves. 

The  payment  of  dividends  out  of  capital  instead  of 
out  of  earnmgs  is  a  practice  which  we  shaU  have  occasion 
to  refer  to  later  in  this  volume.  All  that  need  be  said 
about  It  here  is  that  it  might  obviously  be  used  as  a  means 
of  divertmg  to  stockholders  assets  pledged  to  creditors 
of  the  corporation  and  for  that  reason  is  not  permis- 
sible. ^ 

29.  Rights  of  creditors.— ThQ  creditors  of  a  corpora- 
tion are  of  two  distinct  kinds,  secured  and  unsecured. 
Ihe  secured  creditors  are  those  who  have  had  set  aside 
lor  them  under  some  form  of  agreement  certain  parts 
of  the  property  of  the  corporation  wliich  are  to  be 
devoted,  in  case  the  corporation  fails  at  the  specified 
time  to  meet  its  debt,  to  paying  the  creditor  in  full. 
Ihe  exact  procedure  will  be  discussed  at  some  length 
m  connection  with  corporate  notes  and  bonds.     The 
unsecured  creditors  hold  simply  a  claim  against  the 
general  unattached  assets  of  the  corporation. 

Whether  the  creditors  be  secured  or  unsecured,  they 
have  no  part  in  the  organization  or  management  of  the 
corporation  so  long  as  the  debts  to  them  are  fully  and 
promptly  met.  Only  in  case  of  insolvency  or  bank- 
ruptcy may  they  step  in  and  exercise  any  rights  which 
may  have  been  conditionally  granted  t^  them.  We  wiU 
therefore  defer  a  study  of  their  place  in  the  corporate 
organization  until  we  come  to  the  subjects  of  insolvency 
bankruptcy  and  reorganization. 

30.  "Dummy"  directors.— The  statutes  of  nearly  all 
the  states  require  that  the  directors  of  a  corporation 


INTERIOR  ORGANIZATION 


45 


shall  also  be  stockholders.  In  most  states  the  owner- 
ship of  a  single  share  is  sufficient  to  meet  this  re- 
(juirement.  As  an  example  of  the  striking  difference 
at  times  between  what  the  law  intends  and  what  it  ac- 
complishes, this  requirement  deserves  special  mention. 
Obviously  it  is  intended  to  prevent  any  one  man  from 
"packing"  the  board  of  directors;  In  practice  it  serves 
to  facilitate  the  creation  of  and  control  over  "dummy" 
directors. 

A  dummy  director  is  one  who  serves  the  interest  of 
some  other  person  and  who  votes  as  he  is  told.  Some- 
times he  is  an  actual  stockholder  or  is  given  stock  out- 
right in  order  to  qualify  him  for  his  position,  and  the 
man  who  controls  him  depends  on  influences  outside 
the  corporation  to  retain  his  control.  When  any 
doubt  exists  as  to  that  point,  however,  the  "dummy" 
director  usually  receives  a  certificate  of  stock  duly 
transferred  to  him  on  the  books  of  the  company — which 
thus  qualifies  him  to  act  as  director — but  is  required  to 
endorse  the  certificate  back  to  the  real  owner.  Thus 
the  owner  of  the  stock  always  has  a  string  tied  to  the 
"dummy"  director.  If  his  orders  are  not  followed  to 
his  satisfaction,  all  that  he  needs  to  do  is  to  send  in  the 
certificate,  have  the  stock  transferred  back  to  himself 
and  thereby  disqualify  the  "dummy."  Thus  a  major- 
ity stockholder  may  elect  a  whole  board  of  directors 
who  are  absolutely  subservient  to  his  orders  and  repre- 
sent only  his  interests.  He  may  not  himself  be  a 
member  of  the  board  at  all,  and  yet  may  dictate  its 
every  action. 

31.  Potters  and  liabilities  of  directors. — In  theory, 
however,  even  if  not  in  practice,  a  board  of  directors  is 
supposed  to  represent  all  the  stockholders  equally. 
Partly  for  that  reason  the  board,  as  has  already  been 


46 


CORPORAnON  FINAxNCE 


M' 


SJ 


indicated,  is  given  complete  control  over  the  corpora- 
tion s  assets  and  officers.     Very  seldom,  indeed,  will  the 

short  of  selhng  or  mortgaging  the  corporation's  perma- 
nent assets  unless  fraud  or  wrongdoing  is  conclusively 
shown.     Their  powers  are  usually  more  or  less  modified, 
however   by  the  corporation's  by-laws,  and,  like  othe^ 
officers,  they  are  not  at  liberty  to  transgress  or  omit  any 
of  the  duties  specifically  set  forth  in  the  by-laws     As 
a  general  thing  they  have  power  among  other  things 
to  fill  vacancies  m  their  own  number  until  the  next 
annual  meeting  of  the  stockholders  for  the  election  of 
directors,  to  appoint  and  remove  officers  of  the  corpo- 
ration, and  under  limitations  to  modify  or  enact  by-laws 
Any  or  all  of  these  powers  the  board  of  directors 
may  delegate  if  they  see  fit,  to  a  standing  committee 
chosen  from  their  number.     Where  the  board  of  direct- 
ors  IS  so  large  as  to  be  unwieldy  and  difficult  to  assemble 
at  regular  intervals,  such  delegation  of  powers  is  cus- 
tomary^   The  board  of  directors  of  the  United  States 
Steel    Corporation,    for    example,    which    consists    of 
twenty-four  members,  delegates  a  large  part  of  its  func 
tions  to  a  standing  committee  of  eight  members  known 
as  the  finance  committee.    The  finance  committee  holds 
trequent  meetings  and  conferences  with  the  chairman 
of  the  board  of  directors,  and  between  meetings  of  the 
full  board  has  complete  authority  to  settle  most  ques- 
tions.    It  also  handles  with  full  authority  such  financial 
questions  as  m  most  corporations  would  be  referred  to 
the  board  of  directors.    The  committee  with  these  func- 
tions in  most  corporations  is  caUed  the  executive  com- 
mittee. 

The  usual  duties  of  corporation  officers  have  already 
been  treated  in  the  preceding  chapter.     One  officer  not 


INTERIOR  ORGANIZATION 


47 


ntioned  there,  who  is  in  several  large  corporations 
r  .  .ch  importance,  is  the  chairman  of  the  board  of 
(iix^  cors.  In  the  United  States  Steel  Corporation, 
the  New  York  Central  Railroad  Company,  the 
National  City  Bank  of  New  York,  and  other  companies 
of  like  magnitude,  the  chairman  of  the  board  of 
directors  is  a  prominent  officer  to  whom  the  president  of 
the  corporation  sometimes  reports.  It  would  not  be  far 
from  wrong  to  say  that  the  chairman  represents  the 
board  of  directors  and  the  standing  committees  of  the 
board  in  the  intervals  between  meetings.  To  him,  in 
other  words,  are  delegated  ad  interim  many  of  the 
powers  of  the  board. 

Personal  liabilities  of  directors  may  arise  in  four  ways: 

(1)  By  reason  of  neglect  or  wrongdoing  on  their 
part  that  results  in  loss  to  the  company. 

(2)  By  issuing  stock  as  full  paid  that  is  not  actually 
full  paid. 

(8)   By  paying  dividends  out  of  capital. 

(4)  By  doing  other  acts  specifically  forbidden  by  the 
statutes  of  the  state  in  which  the  company  is  incorpo- 
rated. 

These  acts,  it  should  be  observed,  in  the  eyes  of  the 
law  are  wrong  and  fraudulent.  So  long  as  the  direct- 
ors keep  within  the  law,  no  liability  will  .ittach  to  them 
in  their  capacity  of  directors. 

32.  The  efficiency  of  corporate  organization. — The 
reader  may  now  see  more  clearly  perhaps  why  "central- 
ization of  control"  was  named  in  the  first  chapter  as  one 
of  the  important  advantages  of  corporations.  He  may 
carry  away  a  more  vivid  idea  of  the  who'e  arrangement 
if  he  compares  the  corporation  to  a  double  pyramid,  as 
shown  in  this  diagram: 


COKl'OUATIOX  FINANCE 


S 


i 

! 

I 


CLERKS  AND  LABORERS 


The  base  of  one  pyramid  represents  the  body  of  stock- 
holders or  owners  of  the  corporation  who  delegate  their 
rights  as  owners  to  the  directors,  who  in  turn  transfer 
all  active  autliority  to  the  jjresident  or  other  chief  execu- 
tive officer,  wlio  is  at  the  apex  of  that  pyramid.     The 
other  pyramid  represents  the  subordinate  officials  and 
employees   of  the    corporation.     The   chief   executive 
officer  is  also  the  apex  of  this  pyramid  and  transmits 
his  orders  through  the  various  grades  of  subordinates 
to  the  clerks  and  lalxirers  at  the  base  of  the  pyramid. 
Thus   responsibility   and   authority   conferred   by  the 
stockholders     id  exercised  over  the  employees  are  both 
centered  in  this  chief  executive  officer.     It  is  an  organ- 
ization almost  ideally  adapted,  so  far  us  efficiency  and 
ect)nomy  go,  to  the  conditions  of  present-day  industry. 


CHAPTER  IV 

WHERE  AND  HOW  TO  INCORPORATE 

33.  A  corporation  may  he  chartered  in  any  state  and 
do  business  in  other  states.— The  reader  is  probably  well 
aware  that  a  corporation  need  not  necessarily  take  out 
a  charter  in  the  state  in  which  it  transacts  its  principal 
business.  In  fact,  the  great  majority  of  the  large  in- 
dustrial and  raih-oad  companies  are  incorporated  in  one 
state  and  carry  on  their  operations  in  several  states;  in 
many  cases  none  of  their  permanent  assets  worth  men- 
tioning are  located  in  the  state  of  incorporation. 

This  anomalous  condition  is  made  possible  by  the 
peculiar  character  of  our  American  political  system. 
Each  state  has  the  right  to  create  corporations  and  by 
custom  such  corporations  are  recognized  and  allowed  the 
usual  rights  and  privileges  in  all  other  states.  It  should 
l)e  noted  at  this  point  that  such  rights  and  privileges 
are  granted  as  a  matter  of  custom  and  of  policy,  or 
of  "comity,"  to  use  the  legal  term,  and  not— as  is  some- 
times stated  even  in  legal  text-books— under  that  clause 
of  the  Constitution  of  the  United  States  which  says 
that  "the  citizens  of  each  state  shall  be  entitled  to  all 
])rivileges  and  immunities  of  citizens  in  the  several 
states."  A  corporation  is  not  a  citizen,  but  an  artificial 
IKTson  created  by  law,  which  is  an  entirely  different 
thing. 

In  an  early  case  before  the  Supreme  Court  of  the 
IJnited  States,  The  Bank  of  Augusta  vs.  Earle,  the 
right  of  a  corporation  to  make  a  contract  outside  the 

C— VI— 4  4tf 


50 


CORPORATlOxX  FINAxNCE 


i 


state  of  its  incorporation  was  brou^rht  into  question. 
The  decision  of  the  Court  upheld  this  right  as  a  legal 
presumption,  but  stated  that  the  right  might  be  with- 
drawn by  any  state  legislature.  The  opinion  written 
I  by  Chief  Justice  Taney  is  so  important  and  informing 

i  that  some  of  the  salient  paragraphs  are  quoted  below; 

I  ^*  '*  "^^'y  true  that  a  corporation  can  have  no  legal  existence 

I  out  of  the  boundaries  of  the  sovereignty  by  which  it  is  created. 

*  It  exists  only  in  contemplation  of  law,  and  by  force  of  law ;  and 

.  whe.-e  that  law  ceases  to  operate,  and  is  no  longer  obligatory,  the 

j  corporation  can  have  no  existence.     It  must  dwell  in  the  place 

:  of  its  creation  and  cannot  migrate  to  another  sovereignty.     But 

although  it  must  live  and  have  its  being  in  that  state  alone,  yet 
j  it  does  not  by  any  means  follow  that  its  existence  there  will  not 

;  be  recognized  in  other  places;  and  its   reside  cr   in  one  state 

creates  no  insuperable  objection  to  its  power  of  contracting  in 
another.     It  is  indeed  a  mere  artificial  being,  invisible  and  in- 
tangible; yet  it  is  a  person,  for  certain  purposes  in  contempla- 
tion of  law,  and  has  been  recognized  as  such  by  the  decisions 
of  this  court.     .     .     .     Now,  natural  persons,  through  the  in- 
tervention of  agents,  arc  continually  making  contracts  in  coun- 
tries in  which  they  do  not  reside ;  and  where  they  are  not  per- 
sonally present  when  the  contract  is  made;  and  nobody  has  ever 
doul>ted  the  validity  of  these  agreements.     And  what  greater 
objection  can  there  be  to  the  capacity  of  an  artificial  person, 
by  its  agents,  to  make  a  contract  within  the  scope  of  its  limited 
powers,  in  a  sovereignty  in  whicli  it  does  not  reside;  provided 
such  contracts  arc  pennitted  to  be  made  by  them  by  the  laws 
of  the  place? 

The  corporation  must  no  doubt  show  tliat  the  law  of  its  crea- 
tion gave  it  authority  to  make  sucli  contracts,  through  such 
agents.  Yet,  as  in  the  case  of  a  natural  person,  it  is  not  neces- 
sary that  it  should  actually  exist  in  tlie  sovereignty  in  which  the 
contract  is  made.  It  is  sufficient  that  its  existence  as  an  artificial 
person,  in  the  state  of  its  creation,  is  acknowledged  and  recog- 
nized by  the  law  of  the  nation  where  the  dealing  takes  place; 


WHERE  AND  HOW  TO  INCORPORATE  51 

and  that  it  is  permitted  by  the  laws  of  that  place  to  exercise 
there  the  powers  with  which  it  is  endowed. 

It  is  nothing  more  than  the  admission  of  the  existence  of  an 
artificial  person  created  by  the  law  of  another  state,  and  clothed 
with  the  power  of  making  certain  contracts.  It  is  but  the  usual 
comity  of  recognizing  the  law  of  another  state. 

We  think  it  is  well  settled,  that  by  the  law  of  comity  among 
nations,  a  corporation  created  by  one  sovereignty  is  permitted 
to  make  contracts  in  another,  and  to  sue  in  its  courts ;  and  that 
the  same  law  of  comity  prevails  among  the  several  sovereignties 
of  this  Union.  The  public  and  well-known  and  long-continued 
usages  of  trade ;  the  general  acquiescence  of  the  states ;  the  par- 
ticular legislation  of  some  of  them,  as  well  as  the  legislation  of 
Congress ;  all  concur  in  proving  the  truth  of  this  proposition. 

84.  The  regulation  of  "foreign"  corporations. — In 
the  state  in  which  its  charter  is  granted  a  corporation 
is  called  "domestic" ;  in  other  states  it  is  a  "foreign"  cor- 
poration. This  word  "foreign"  must  not  be  taken  to 
refer  to  corporations  of  other  countries  than  the  United 
States;  such  corporations  are  known  as  "alien." 

Every  state  in  the  Union  regulates  to  a  greater  or 
less  degree  the  business  carried  on  within  its  borders 
by  foreign  corporations.  In  some  states  it  is  necessary 
to  procure  a  license,  which  may  be  obtained  by  deposit- 
ing with  some  official  a  certified  copy  of  the  corpora- 
tion's charter  and  naming  some  agent  on  whom  legal 
papers  may  be  served.  In  other  states  it  is  merely 
required  that  the  foreign  corporation  shall  maintain  an 
office  and  have  an  agent  within  the  state.  Some  states 
restrict  the  power  of  foreign  corporations  to  hold  real 
'  .tate.  These  regulations  are  not  intended  to  apply 
to  corporations  which  merely  solicit  orders  or  execute 
contracts  incidental  to  their  main  business,  but  to  those 
which  are  permanently  established. 


•52 


CORPORATION  FINANCE 


ii 


I 


^'y.  Choosing    the    state    of   ineorporation.—Vnless 
there  ir  jome  reason  to  the  contrary,  it  is  generally  much 
better  for  a  corporation  to  get  its  charter  in  the  state 
in  which  its  principal  business  is  located.     This  remark 
applies    particularly    to    small    companies    operating 
wholly  within  one  state.     There  are  several  reasons 
therefor.     One  is  the  fact  that  a  foreign  corporation 
must  usually  pay  incorporation  and  annual  franchise 
taxes  in  the  state  of  incorporation  and  in  addition  a 
license  fee  or  some  other  kind  of  a  tax  in  the  state  in 
which  it  does  business.     Another  reason  is  that  the  courts 
of  each  state  are  inclined  to  treat  domestic  corpora- 
tions with  greater  considera  ,ion  than  foreign  corpora- 
tions.    A  third  reason  is  that  there  is  a  popular  prej- 
udice, more  or  less  well-founded,  against  those  companies 
which  go  to  other  states  for  their  charter.     Creditors 
and  prospective  buyers  of  the  corporation's  securities 
are  apt  to  ask  embarrassing  questions  as  to  why  the 
coT-poration  cannot  or  does  not  comply  with  the  legal 
requirements  of  its  own  state.     A  fourth  reason  is  the 
inconvenience  caused  by  the  necessity  of  filing  reports 
and  generally  of  maintaining  a  separate  office  in  the 
state  of  incorporation.     If  the  managers  of  a  small 
local  concern,  therefore,  are  considering  where  to  in- 
corporate, the  answer  will  almost  always  be,  "Get  your 
charter  in  the  state  where  you  expect  to  do  most  of 
your  business." 

The  answer  to  a  similar  question  is  not  so  easy,  how- 
ever, where  the  prospective  corporation  will  be  large, 
or  where  its  business  will  be  widely  scattered  through 
many  states,  or  where  its  managers  have  in  view  some 
purpose  or  purposes  not  avored  by  the  laws  of  the 
state  in  which  its  principal  office  is  to  be  located. 
Neither  is  the  answer  so  easy  even  for  small  local  con- 


WHERE  AND  HOW  TO  INCORPORATE  53 


ccrns  in  those  ultra-conservative  states  in  which  the 
corporation  laws  are  unduly  burdensome  or  corporation 
taxes  unduly  expensive.  Under  all  these  circumstances, 
persons  who  are  about  to  form  a  new  corporation,  or 
who  are  thinking  of  giving  up  their  charter  in  one 
state,  will  naturally  look  about  and  compare  the  ad- 
vantages obtainable  under  the  laws  of  the  various  states. 
There  are  great  variations  among  the  states  in  regard 
to  taxes,  liberality  of  corporation  laws  and  treatment  of 
foreign  corporations,  and  the  problem  of  weighing  all 
these  factors  and  picking  out  the  most  economical  and 
advantageous  corporate  home  is  often  very  difficult. 
The  advice  of  a  thoroughly  competent  corporation 
lawyer  in  all  such  cases  is  absolutely  essential.  Never- 
tiieless,  for  his  own  protection,  both  in  forming  and  in 
dealing  with  corporations,  every  business  man  should 
have  a  pretty  accurate  idea  of  the  requirements  and 
prinleges  in  all  the  important  states. 

86.  Comparative  charges  in  several  states. — The  first 
and  most  obvious  factor  to  consider  in  selecting  the  state 
of  incorporation  is  the  cost.  This  cost  consists  of 
organization  fees,  annual  taxes  and  counsel  fees.  The 
following  tables  copied  from  a  convenient  manual  by 
Thomas  Conyngton,  of  the  New  York  Bar,  entitled 
"Corporate  Organization,"  will  give  the  reader  an  idea 
of  how  these  expenses  run  in  the  five  states  which  are 
most  commonly  used  for  incorporation  by  companies 
that  expect  to  do  business  in  other  states: 

COMPARATIVE  TABLE  OF  ORGANIZATION  EXPENSES. 


Capital  Stock 
of  Company. 

f  1,000 
5,000 

10.000 


(Including  all  Filing  and  Incidental  Fen.) 


Jtr$0y. 

fSA.OO 
SA.OO 
35.00 


N0W 

York. 

116.00 

17.50 

90.00 


Dtlavart. 

i?5.00 

95.00 

95.00 


JitAnt. 

197.00 
97.00 
97.00 


South 

Dakota. 

113.00 

13.00 

13.00 


54 


CORPORATION  FINANCE 


Capital  Stock 

New 

Sew 

South 
Dakota. 

of  Company. 

Jer»ey.       York. 

Delaware. 

Maine, 

25,000 

35.00 

27.50 

25.00 

67,00 

13.00 

50,000 

35.00 

40.00 

25.00 

67.00 

18.00 

100,000 

35.00 

65.00 

25.00 

67.00 

18.00 

500,000 

110.00 

265.00 

65.00 

67.00 

23.00 

1,000,000 

210.00 

515.00 

115.00 

117.00 

33.00 

5,000,000 

1,010.00 

2.515.00 

:165.00 

517.00 

113.00 

10,000,000 

3,010.00 

5,015.00 

615.00 

1,017.00 

133.00 

COMPARATIVE  TABLE  OF  ANNUAL  FRANCHISE  TAXES. 

91,000 

$1.00 

$1.50 

$5.00 

$5.00 

None 

5,000 

5.00 

7.50 

5.00 

5.00 

u 

10,000 

10.00 

15.00 

5.00 

5.00 

u 

25,000 

25.00 

37.50 

5.00 

5.00 

u 

50,000 

50.00 

75.00 

10.00 

5.00 

M 

100,000 

100.00 

150.00 

10.00 

10.00 

« 

500,000 

500.00 

750.00 

25.00 

50.00 

« 

1,000,000 

1,000.00 

1,500.00 

50.00 

75.00 

H 

5,000,000 

4,000.00 

7,500.00 

150.00 

275.00 

M 

10,000,000 

V50.00 

15,000.00 

275.00 

525.00 

« 

South  Dakota  and  Delaware  are  fair  examples  of 
what  are  sometimes  called  the  "barifain  counter"  states, 
so    far    as    incorporation    expenses    are    concerned. 
Arizona  also  belongs  in  this  class,  and  West  Virginia 
and  the  District  of  Columbia  might  until  recently  have 
been  included.    As  an  example  of  the  importance  of 
this  feature  when  large  companies  are  formed,  it  has 
been  estimated  that  if  the  United  States  Steel  Corpora- 
tion had  taken  out  its  charter  in  Pennsylvania,  where 
most  of  its  business  is  transacted,  the  organization 
expenses  would  have  been  about  $3,500,000,  whereas  in 
New  Jersey,  where  the  charter  was  actually  obtained,  the 
corresponding  expenses  were  only  about  $220,000.     A 
great  many  companies  which  are  organized  to  exploit 
mines  or  new  inventions  or  other  highly  speculative  en- 
terprises may   without   impropriety   issue   very   large 
amounts  of  stock,  although  the  actual  market  value  of 
their  assets  at  the  time  of  incorporation  may  be  verj' 


WHERE  AND  HOW  TO  INCORPORATE 


55 


small;  in  such  cases  it  is  customary  and  obviously 
tconomical  to  secure  a  "bargain  counter"  charter. 

In  those  states  where  taxes  and  initial  fees  are  small 
the  necessary  expense  for  legal  assistance  is  apt  to  be  at 
a  minimum,  for  two  reasons:  first,  because  the  state 
legislatures  obviously  are  making  a  bid  for  the  cheap 
incorporation  business  and  will  naturally  make  their 
forms  and  the  necessary  red  tape  of  incorporation  as 
simple  as  possible;  second,  because  in  such  states  incor- 
poration agencies  which  carry  on  their  business  on  a 
wholesale  scale,  are  in  existence,  and  high-priced  legal 
talent  is  hardly  necessarj'.  In  other  states  competent 
attorneys  should  always  be  secured,  and  their  fees  may 
l)e  expected  to  range  from  $50  up.  In  this  connection 
it  may  be  well  to  remark  also  that  the  necessary  corpo- 
rate records,  wliich  are  the  secretary's  minute  book, 
the  stock  certificate  book  and  the  stockholders'  register, 
may  be  obtained  for  from  $10  to  $500  per  set.  One  of 
the  cheaper  sets  is  all  that  is  necessary  for  most  small 
companies.  The  reader  now  has  sufiicient  data  before 
him  to  form  a  rough  estimate  of  the  expense  necessarily 
involved  in  the  process  of  incorporation. 

This  factor  of  initial  cost,  however,  in  the  case  of 
companies  which  expect  permanently  to  car^'  on  an 
established  business  is,  after  all,  a  minor  consideration. 
Among  the  other  important  points  to  bear  in  mind  in 
selecting  a  corporate  domicile,  four  stand  out  most 
prominently — the  liberality  of  the  laws,  the  permanence 
of  the  laws,  the  liabilities  attaching  to  stockholders 
and  the  reputation  of  the  state. 

87.  Liberality  of  corporation  laws  in  several  states. — 
The  chief  respect  in  which  state  laws  differ,  so  far  as 
lil)erality  is  concerned,  is  in  granting  or  denying  the 
right  to  buy  and  sell  the  securities  of  other  corporations. 


V" 


56 


CORPORATION    FINANCE 


In  1889  New  Jersey,  first  of  all  the  states,  enacted  that 
corporations  formed  under  its  laws  might  hold  the  stock 
of  other  corporations.    This  privilege  proved  of  great 
importance  in  the  financial  and  industrial  development 
of  this  country.    The  Xew  Jersey  act  in  this  respect  was 
followed  by  Delaware,  Maine  and  New  York.    In  1913 
however,  through  the  so-called  "Seven  Sisters  Law," 
New  Jersey  attempted  to  define  and  make  illegal  and 
criminal  all  monopolies  and  agreements  to  discriminate, 
prevent  competition,  limit  production  and  fix  prices. 
The  great  industrial  trusts,  which  formerly  patronized 
this  state  when  incorporating  new  companies,  are  now 
obliged  to  look  elsewhere. 

Another  feature  in  which  the  various  states  differ 
widely  with  regard  to  liberahty  is  the  issuance  of  stock 
for  property.     Most  corporations   as  now  organized 
turn  over  at  least  part  of  their  stock  in  exchange  for 
property,  not  cash.    Some  of  the  states  make  the  esti- 
mate placed  by  the  directors  upon  the  value  of  the  prop- 
erty so  secured  conclusive  unless  fraud  is  clearly  shown. 
Other  states  hedge  this  general  principle  about  with 
irntatmg  and  usually  unnecessary  restrictions.    Liber- 
ality of  the  state  laws  as  to  other  less  important  points 
will  be  considered  by  careful  incorporators,  but  are  too 
technical  to  be  discussed  here. 

88   Permanence  of  the  lawa.-ln  those  states   in 
which  the  general  corporation  statutes  have  existed  for 
some  years  practically  unchanged,  it  is  reasonable  to  ex- 
pect that  they  are  in  fairly  permanent  form.    Moreover 
m  such  states  the  courts  have  given  a  large  number  of 
decisions  on  vital  points.    Both  the  statutory  law  and 
the  interpretation  of  that  law,  therefore,  may  be  con- 
s^ered  well  settled.    This  is  a  matter  of  prime  impor- 
tance to  large  corporations,  which  may  expect,  from  the 


WHERE  AND  HOW  TO  INCORPORATE 


57 


very  extent  of  their  business,  to  be  involved  in  more  or 
less  litigation.  They  want  to  know  where  they  stand 
at  all  times  and  do  not  care  to  be  confronted  with  sudden 
legislative  enactments  or  with  unexpected  court  de- 
cisions. For  this  reason  the  large  corporations  which 
had  incorporated  in  New  Jersey  were  especially  hard 
hit  when  the  "Seven  Sisters  Amendments"  were  suddenly 
enacted. 

The  liabilities  imposed  upon  stockholders  have  al- 
ready been  treated  in  the  preceding  chapter.  The 
states  of  California,  New  York  and  Minnesota,  as 
there  noted,  impose  certain  liabilities  additional  to  the 
usual  liability  on  capital  stock.  These  liabilities  are 
not  apt  to  prove  a  serious  matter.  Yet  corporations  gen- 
erally look  with  some  alarm  at  any  provisions  of  this 
nature. 

39.  Reputations  of  various  states. — The  reputation 
of  the  state  of  incorporation  may  have  considerable 
effect  on  the  sale  of  corporate  securities.  It  is  so  well- 
known,  for  instance,  that  the  laws  of  South  Dakota 
and  Arizona  are  lax  that  investors  look  with  distrust 
on  any  corporation  which  operates  under  one  of  their 
charters.  This  statement,  although  to  a  much  less  de- 
gree, applies  to  Delaware  and  to  Maine.  Delaware  is 
now  especially  popular,  having  in  part  displaced  New 
Jersey  after  the  legislation  already  referred  to.  West 
Virginia  and  the  District  of  Columbia  do  not  rank 
nearly  so  well,  on  account  of  their  record,  although 
the  District  of  Columbia  law  in  1905,  on  the  recom- 
mendation of  President  Roosevelt,  was  altered  and 
improved  and  the  West  Virginia  law  also  has  been 
changed.  Connecticut,  :Massachusett8,  Pennsylvania 
and  Illinois  have  reasonably — Massachusetts  perhaps 
unreasonably — strict  requirements,  and  all  as  states 
of  incorporation  are  in  good  repute.    Among  all  the 


58 


CORPORATION  FLVANCE 


States,  New  York,  under  its  "Business  Corporations 
l^aw,  as  amended  in  recent  years,  perhaps  best  com- 
bines the  advantages  of  hberahty  and  of  high  repute. 
Its  laws  however,  have  not  been  so  thoroughly  tested 
and  settled  by  the  courts  us  the  corresponding  laws  of 
'New  Jersey. 

40.  Comparative  summary  of  the  advantages  and 
disadvantages  of  the  important  states.—For  the  benefit 
of  readers  who  may  desire  to  form  a  corporation  or  who 
may  have  occasion  to  consider  the  advisability  of  buying 
stock  of  a  company  incorporated  in  some  other  state 
than  the  one  in  which  it  does  business  we  give  below  a 
bnef  summary  of  the  ad^antages  and  disadvantages  of 
several  states:  ® 

ASIZONA. 

Advantaget: 

1.  Stock  may  be  issued  for  money,  property,  or  services. 
JdvanL  '*"       '''"''*  ^'''  '''^''''  "^^  ^'  ^"^  important 

2.  Directors'  meetings  may  be  held  outside  of  the  state. 

3.  The  organization  fee  is  very  small.     The  annual  franchise 
tax  IS  small. 

4.  Cumulative  voting  is  permitted. 
Disadvantages: 

1.  Stockholders'  meetings  must  be  held  within  the  state,  unless 
at  first  meetmg  a  by-law  provision  permitting  subsequent  meet- 
mgs  outside  the  state  is  adopted. 

2.  The  corporation  laws  are  not  thoroughly  adjudicated. 

CONNECTICUT. 

Many  promoters  do  not  care  to  incorporate  in  Connecticut  as 
they  'rnagine  that  the  advantages  are  not  great.    As  a  matter 
of  fact,  the  high  organization  fee  is  the  chief  disadvantage. 
Advantages : 

1.  Stock  may  be  paid  for  in  either  cash  or  property.     The 
judgment  of  the  directors  is  final  with  regard  to  the  value  of 


WHERE  AND  HOW  TO  INCORPORATE 


59 


the   property   for   which    stock   is   issued,   except   in    case   of 
fraud. 

2.  Incorporators  may  be  non-resident. 

S.  There  is  no  annual  franchise  tax. 

4.  Corporations  may  hold  stock  in  other  corporations. 

Dinadvati^aget  : 

1.  Stockholders'  meetings  must  be  held  within  the  state. 
There  is  no  provision  requiring  the  meetings  of  the  directors  to 
be  held  within  the  state,  but  this  may  be  inferred. 

fi.  There  is  an  inheritanr   tax  on  the  stock. 

9.  The  organization  f et:^  are  comparatively  high,  from  $S6  to 
$2,510. 

DELAWAEK. 

Advantages: 

1.  Stockholders*  and  directors'  meetings  may  be  held  outside 
of  the  state,  if  the  by-laws  so  provide. 

2.  Stock  may  be  issued  for  cash,  property  or  services. 

3.  Incorporators  may  be  non-resident. 

4.  Corporations  may  hold  stock  in  other  corporations. 

5.  Provision  may  be  made  whereby  bondholders  will  be  per- 
mitted to  vote.  This  provision  makes  a  good  market  for  bonds 
because  bondholders  will  be  assured  that  they  will  have  a  voice 
in  the  management  of  the  corporation. 

6.  Organization  fees  are  not  very  large,  ranging  from  $30  to 
$765,  including  filing  fees. 

Disadvantages : 

1.  One  of  the  directors  must  live  in  Delaware. 

2.  There  is  an  inheritance  tax  on  stock,  applying  both  to  resi- 
dents and  to  non-residents. 

3.  There  is  an  annual  franchise  tax. 

BISTKICT  OF  COLUMBIA. 

Advantages: 

1.  Very  small  cost  of  incorporation,  probably  not  exceeding 
$10. 

it.  No  franchise  or  inheritance  tax. 


i 


i 


GO 


CORPORATION  FINANCE 


Disadvantages: 

1.  A  majority  of  the  trustees,  (the  term  trustee  corresponds 
to  the  term  director)  must  live  in  the  District. 

2.  Stock  cannot  be  issued  for  services,  only  for  property  or 
CAsn* 

3.  10  per  cent  of  capital  stock  must  be  paid  in  before  begin- 
ning business.  New  York  requires  50  per  cent  paid  in  before 
the  end  of  the  first  year,  but  business  can  be  carried  on  in  the 
meantime.  Here,  no  business  can  be  (lone  in  the  name  of  the 
corporation  tiU  10  per  cent  is  fully  paid  in. 

4.  An  annual  report  of  the  corporation  must  be  filed  and 
published.  This  report  must  include  amount  of  capital  stock 
authorized,  amount  paid  in  and  amount  of  existing  debts. 

5.  The  corporation  cannot  own  stock  in  other  corporations. 

6.  Corporation  laws  are  unadjudicated. 

MAINE. 

Advantages: 

1.  Stock  may  be  issued  for  property,  cash  or  services.  The 
judgment  of  the  dirt  tors  is  conclusive  as  to  value  of  the  prop- 
erty—always provided  there  is  no  evidence  of  fraud. 

«.  Incorporators  and  directors  may  be  non-resident 

3.  Directors'  meetings  may  be  held  outside  of  the  state. 

4.  The  corporation  may  acquire  stock  in  other  corporations. 
6.  Low  organization  fees,  ranging  from  $10  to  $617  for  a 

$5,000,000  corporation. 

Disadiran  tages : 

1.  Stockholders'  meetings  must  be  held  within  the  state. 

2.  There  is  both  an  inheritance  and  an  annual  franchise  tax ; 
the  latter,  however,  is  very  small. 


MASSACHUSETTS. 

Advantages: 

1.  Incorporators  and  directors  may  be  non-resident. 

2.  Directors'  meetings  may  be  held  outside  of  the  state. 

3.  Stock  may  be  issued  for  cash,  property  or  services. 


WHERE    AND    HOW    TO   INCORPORATE        61 


Disadx'aniaget : 

1.  Stockholders'  meetings  must  be  held  within  the  state. 

2.  It  is  doubtful  whether  ordinary  corporations  can  hold 
stock  in  other  corporations. 

3.  A  detailed  annual  report  must  be  rendered  to  the  state  au- 
thorities. 

4.  There  is  an  inheritance  tax. 

5.  The  organization  fee  varies  from  $26  for  a  $10,000  cor^ 
poration  to  $1,S00  for  a  $5,000,000  corporation. 

.  J         .  NEVADA. 

Advantaget: 

1.  Incorporators  and  directors  may  be  non-resident. 

2.  Stockholders'  and  directors'  meetings  may  be  held  outside 
of  the  state. 

3.  Stock  may  be  issued  for  cash,  property  or  services.  The 
judgment  of  the  directors  is  conclusive  as  to  value  of  prop- 
erty, providing  there  is  no  evidence  of  fraud. 

4.  Action  of  the  majority  of  the  stockholders  or  directors 
may  be  valid  witho''t  regular  meeting;  that  is,  there  may  be 
an  informal  meeting  held,  without  any  notice  whatsoever  being 
given. 

5.  Bondholders  may  be  given  the  right  to  vote. 

6.  Cumulative  voting  is  allowed. 

7.  No  annual  franchise  tax. 

8.  The  organization  fee  is  comparatively  low,  ranging  from 
$15  to  $700;  there  are  no  filing  fees  except  those  imposed  by 
counties. 

Disadvantages: 

1.  In  some  cases  an  annual  report  must  be  prepared  for  the 
state  authorities. 

2.  The  state's  reputation  as  a  corporate  home  is  not  of  the 
best. 

.J         .  NEW  JERSEY. 

Advantages: 

1.  Corporations  may  hold  stock  in  other  non-compet'tive  cor- 
porations. New  Jersey  was  the  first  state  to  authorize  the  for- 
mation of  holding  companies. 


62 


u  I 

i 


CORPORATION    FINANCE 


2.  Incorporntors  nmy  be  non-resident. 

3    Stock  may  be  issued  for  property  or  cash.     Ju.lgment  of 
the  directors  ,s  conclusive  as  to  vahie  of  property.    The  courts 
however,  have  shown  a  strong  tendency  to  accept  circumstantial 
evidence  of  fraud. 

4.  Direct-     '  .nectings  may  be  held  outride  of  the  sUte.  if 
by-laws  so  p         Je. 

5.  Cumula.  ,.  voting  is  permitted. 

6.  A  voting  t.ust,  un,ler  certain  restrictions,  may  be  created 

7.  Laws  are  all  well  adjudicated. 

Disadvantageg : 

1.  Stockholders'  meetings  must  be  held  within  the  state. 

2.  One  of  the  directors  must  live  in  the  state. 

3.  There  is  an  annual  franchise  tax ;  also  an  inheritance  tax, 

^f Ir  ir  "°*  *PP'^  ***  non-residents.     Fees  are  from  .$25  to 
$1,000;  filing  fee  $10. 

NEW  YOBK. 

Advantaget: 

1.  Stock  may  be  issued  for  cash,  property,  or  labor.  Labor 
must  be  distinguished  from  "services"  though  there  is  no  de- 
cision explaining  the  exact  difference.  The  judgment  of  the 
directors  is  conclusive  as  to  value  of  property,  provided  there  is 
no  evidence  of  fraud. 

2.  Directors'  meetings  may  be  hcio  outside  of  the  state. 

8.  Corporations  may  hold  and  control  the  stock  of  other  cor- 
porations. 

4.  Cumulative  voting  is  permitted. 

6.  A  voting  trust  may  be  created,  limited,  however,  to  five 
years. 

Ditadvantagea: 

1.  Stockholders'  meetings  must  be  held  within  the  sUte. 

2.  One  incorporator  and  one  director  must  reside  within  the 
state. 

3.  One-half  of  the  capital  stock  must  be  ;  aid  in  within  a  year 
from  incorfioratinn. 

4.  Detailed  books  and  account*  of  the  business  are  r«,uire«l. 


WHERE  AND  HOW  TO  INCORPORATE 


68 


41.  Agreements  prior  to  incorporation. — Sometimes 
a  corporation  is  formed  practically  by  and  for  an  in- 
dividual acting  alone,  who  expects  to  take  all  the  stock 
except  what  is  necessary  to  qualify  dummy  directors 
and  either  hold  it  permanently  or  dispose  of  it  whenever 
an  opportunity  arises  later.  Frequently,  also,  it  hap- 
pens that  a  corporation  is  organized  to  take  over  the 
business  of  a  pre-existing  partnership  and  the  partners 
have  come  to  an  informal  understanding  as  to  how  much 
stock  shall  be  issued  to  each  one.  Under  such  circum- 
stances, of  course,  no  formal  agreements  previous  to 
incorporation  are  necessary. 

In  many  instances,  however,  corporations  are  formed 
by  the  harmonious  action  of  a  numl)er  of  men  who 
mutually  agree  as  to  the  purposes,  capitalization  and 
other  essential  features  of  the  new  corporation  and  who 
each  subscribe  for  a  certain  amount  of  stock.  In  such 
cases  it  is  customary  to  draw  up  what  is  known  as  a 
"subscription  contract"  and  to  leave  space  at  the  bottom 
of  this  contract  for  each  subscriber  to  write  his  name 
and  fill  in  the  number  of  shares  that  he  agrees  to  take. 
The  subscription  contract  should  state  among  other 
things  the  par  value  of  each  share  of  stock,  the  total 
number  of  shares  to  be  issued  and  the  total  number  to 
l)e  subscribed,  in  order  to  make  the  contract  binding. 
Usually  the  subscription  list  is  accompanied  by  a  pros- 
pectus (descrilHjd  in  Chapter  XVI)  which  more  fully 
states  what  the  corporation  is  expected  to  accomplish. 
It  i^ould  be  noted  that  the  subscription  contract  may  be 
made  immediately  binding  by  having  the  amount  of 
the  subscription  payable  to  certain  specified  trustees; 
or  if  not  imme<liately  binding,  it  will  liecome  binding  as 
scx)n  as  the  projiosed  cori)oration  is  properly  organized 
and  prepared  to  handle  funds. 


64 


(  ORPOR ATIOX  FI  NANCE 


The  rema.nms-  step  i„  ir,eor,H.ration  is  very  simple 
aiulhas  already  been  touehed  upon  in  Chapter  il.  It 
insists  of  drawing,  „p  a  eharter  in  proper  le^ral  fo,,. 
hhng  ,t  w.th  the  secretary  of  state  or  su'h  other 
offieml  as  .s  desi^mated  l,y  the  laws  of  the  state  in  which 
the  charter  is  to  \ye  obtained,  and  receiving  notice  of 
his  acceptance  thereof. 

42.  The  rchlc  ran^e  of  choice  in  incorporation. -If 
the  reader  has  ac.,uired  by  the  reachng  of  this  chapter 
a  clear  conception  of  the  freedom  and  liln^ralitv  of 
corporatmn  laws  and  of  the  ease  with  which  almost  any 
legitimate  business  may  be  put  into  the  form  of  the  cor- 

S'T'  ^  ^V""'".  ^""■^"''  "*'  '^''  '^'''i''''  ^^•'»  ''^'ve  iH^en 

1.1,  ^    .  "''^■^'"*^'-^'^  "*'  t''^-  eorp(,rate  form  for 

almost  all  km.ls  <,f  business  were  pointed  out  in  the  first 

flcMb.h ty  by  wlHch  was  meant  the  ease  with  which  the 
eorporate  l„rm  could  be  adapted  to  small  or  to  lar.re 
enterprises.  ^ 

Now  we  are  in  a  position  to  expand  still  further  the 

meaning  of  that  word  'flexibility"  i„  connection   with 

corporations  and  to  say  that  it  means  also  the  ease  with 

HJnch  the  eorporate  form  may  be  adjusted  to  anv  sort 

of  a  business  need.     If  the  incorporators  cannot  find  in 

one  state  the  authority  or  the  cheapness  that  they  desire 

hey  may  pick  out  some-  r>ther  state  in  which  thoie  ,iuali- 

ties  are  pnm.inent  in  the  generd  corporati.m  law.     If 

the  incorporators  desire  permanence  and  legal  stability 

above  all  things,  they  may  go  to  still  another  state     The 

range  of  choiee  is  wi.le.    It  takes  only  a  little  effort  and 

mgenuity  for  a  capable  lawyer  to  fit  out  a  business  en- 

terpriH.  with  the  exact  corporate  powers  and  organiza- 

tion  that  will  prove  most  advantageous. 


WHEKE    AND   HOW   TO    INCORPORATE        65 

43.  Canada's  corporation  laics.— The  advantages, 
drawbacks  and  principles  of  the  corporate  form,  dis- 
cussed in  previous  pages,  are  in  a  general  way  applicable 
to  Canada  as  well  as  to  the  United  States.  Here  it  is 
necessary  only  to  examine  briefly  the  corporation  laws 
of  the  Dominion.  Each  of  the  nine  provinces  of  Canada 
has  its  own  company  laws.  In  addition  there  is  the  Com- 
panies' Act  of  the  Dominion,  known  commonly  as  the 
Federal  Act.  This  act  is  divided  into  six  parts.  The 
first  deals  with  joint  stock  companies;  the  second,  with 
companies'  clauses;  the  third,  with  the  incorporation  of 
loan  companies;  the  fourth,  with  British  loan  companies; 
the  fifth,  with  British  and  foreign  mining  companies; 
and  the  sixth  comprises  only  two  clauses  dealing  chiefly 
with  the  payment  of  (lel)entures  by  loan  companies. 

The  Secretary  of  State  at  Ottawa  may  grant  charters, 
on  certain  conditions,  to  not  less  than  five  applicants  who 
must  file  with  him  the  following  information: 

(a)  The  proposed  corporate  name  of  the  company, 
which  shall  not  be  that  of  any  other  known  company, 
incorporated  or  unincorporated,  or  any  name  liable  to 
i»e  confounded  therewith,  or  otherwise,  on  public 
^M-ounds,  objectionable. 

(1))   The   purposes   for  which  the   incorporation   is 

sought. 

(c)  The  place  within  Canada  which  is  to  be  its  chief 
place  of  business. 

(d)  The  pro|K)sed  amount  of  its  capital  stock. 

(c)  The  number  of  shares  a'ul  the  amount  of  each 
share. 

( f )  The  names  in  full  and  the  addresses  and  calling  of 
ciith  of  the  applicants,  with  special  mention  of  the  names 
of  not  more  than  fifteen  and  not  less  than  three  of  their 

(    -VI— 4 


^ 


A 


66 


COHPOUATION    FINANCE 


number,  who  are  to  be  the  first  or  provisional  directors 
oi  the  company. 

(g)  The  amount  of  stock  taken  bv  each  applicant,  the 
amount,  if  any,  paid  in  upon  the  str>ck  <,1'  each  applicant. 
a.id  the  manner  in  which  the  same  has  been  paid,  and  is 
held  for  the  company. 

Existin^r  companies  may  l>e  incorporated  under  this 
act  as  may  also  any  company  incorporated  under  anv 
general  or  special  act  of  any  of  the  Canadian  provinces 
or  under  the  laws  of  the  United  Kingdom  or  anv  foreign 
country'.  There  is  a  tariff  oi'  fees  to  be  paid  on  ap- 
plication for  incorporation.  This  tariff  mav  l)e  varied 
by  the  government  accordin^r  to  the  nature  i)f  the  com- 
pany, the  amount  of  capital  stock,  and  the  like.  A  com- 
pany must  not  CHimmence  it«  operations  or  incur  anv  lia- 
bility before  10  per  cent  of  its  authori/x-d  capital  has 
been  subscribed  and  paid. 

In  order  to  check  traffic  in  charters,  anv  charter  grant- 
ed under  the  Dominion  .Vet  becomes  forfeited  in  case  of 
non-use  by  the  company,  or  in  case  the  company  does 
not  go  into  actual  operation  within  three  vears  after  the 
charter  is  granted. 

The  Dominion  Law  particularly  emphasizes  that  the 
word  "Limited"  must  appear  after  the  company's  name. 
This  applies  to  notices  on  the  crmipanv's  oiKces,'  their  lit- 
erature, bills  of  exchange,  and  other  stationery.  The 
habihty  of  shareholders  is  limited  to  the  amount  unpaid 
on  their  respective  shares  in  the  capital  stock.  The  ques- 
tion of  liability  king  an  iinp(.rtant  one.  we  may  (luote 
sections  39  to  42  of  the  Dominic.n  Companies'  Act  on 
that  point: 


39.   Any  «hiirLh..Mir  may  |il((u|  |,v 
or  ill  p,irt  to  miy  iuti<Mi  liy  «iiv  crediti 


ing  section   of  any    >vt-off  wliit-li    1 


May  of  (Icfoiro  in  wliole 
•  r  uikKi-  III.,  last  j)n<»(|- 


K>  ciui    s«»    lip   uguinst   thu 


WHERE    AND    HOW   TO   INCORPORATE        67 

...mpuny,   except  a  claim  for  unpaid  dividends   or  a   salary 
or  allowance,  ns  a  president  or  a  director  of  the  company. 

K).  No  person  holding  stock  in  the  company  as  an  executor, 
ulinin.strntor,  tutor,  curator,  guardian  or  trustee  of  or  for 
any  person  named  in  the  books  of  the  company  as  being  so 
.vprosonte.1  by  him,  shall  be  personally  subject  to  liability  as  a 
shareholder:  but  the  estate  and  fun.ls  i„  the  hands  of  such  per- 
s.m  shnll  1,0  hnble  in  like  manner,  and  to  the  same  extent  as 
the  testator  or  intestate  would  be  if  living,  or  the  minor,  ward, 
...  mterduf.l  p.rson  or  the  person  interested  in  such  trust 
fm.d  would  be,  ,f  cou.petent  to  act  and  holding  such  stock  in  his 
own  name. 

n.  No  person  holding  such  stock  ns  collateral  security  shall 
I-  personally  subject  to  such  liability,  but  the  person  pledging 
such  stock  shall  Ik.  considon.l  f„r  the  purposes  of  such  liability 
as  hold.ng  the  same  and  shall  be  liable  as  a  shareholder  ac- 
•onbngly. 

42.  Every  such  executor,  n.lministrator,  curator,  guardian 
-•  rustee  shall  represent  the  stock  hehl  by  him,  at  all  meeting, 
•of  the  company,  and  n.ay  vote  as  a  sharehohler;  and  every 
p.  -son  who  plc..l^.es  his  stock  n.ay  represent  the  same  at  aU 
•Muh  meetn,gs,  and  notwithstanding  such  ple.lge,  vote  as  a 
shareholder.  ^      o  , 

The  capital  stcK-k  of  the  company  must  he  personal  es- 
tate  and  tran.sferahle.  The  directors  of  a  company  may 
nmke  by-laws  for  creating  and  issuing  anv  part  of  the 
capital  st(K.k  as  preference  stock.  Several  clauses  of  the 
act  deal  with  the  increase  of  capital. 

If  authorized  by  hy-hiw,  sanctioned  by  a  vote  of  not 
h  ss  than  two-thirds  in  value  of  the  subs'cribed  stock  of 
tin  mnpany  represente<l  at  a  general  meeting  chilv 
nillcd  for  considcrin^rthe  by-law,  the  directors  may  from 
time  to  time:  ^ 

( a )  Horrow  money  uiion  the  credit  of  the  company. 

(b)  Lmiit  or  increase  the  amount  to  be  bormwed. 


ft 

■n  ' 


68 


CORPORATION    FINANCE 


(c)  Issue  bonds,  debentures  or  other  securities  in  the 
com^^any  for  sunis  not  less  than  one  hundred  dollars  each, 
and  pledge  or  sell  the  same  for  siich  sums  and  at  such 
prices  as  may  be  deemed  expedient. 

(d)  Hypothecate,  mortgage,  or  pledge  the  real  or 
personal  property  of  the  company,  or  both,  to  secure  any 
such  bonds,  del)entures  or  other  securities  and  any  money 
borrowed  for  the  purposes  of  the  company. 

No  dividend  must  be  declared  which  will  impair  the 
capital  of  a  company.  The  directorate  may  comprise  not 
more  than  fifteen  and  not  less  than  three.  The  powers 
of  directors  are  fully  si)ecified  in  the  act,  as  is  also  the 
liability  of  directors  and  officers.  They  are  prohibited 
from  declaring  and  paying  a  dividend  when  the  company 
is  insolvent.  They  are  also  liable  for  the  transfer  of 
shares  to  persons  who  are  not  apparently  of  sufficient 
means  to  pay  up  fully  such  shares.  Other  matters  of 
directorial  liability  are  loans  by  companies  to  sharehold- 
ers, wages  unsatisfied  and  premature  commencement  of 
business. 

If  shareholders  are  dissatisfied  they  may  have  an  in- 
vestigation of  their  company's  affairs.  This  is  obtained 
upon  the  application  of  shareholders,  representing  not 
less  than  one-fourth  in  value  of  the  issued  capital  stock 
of  the  company,  to  a  local  ju<lge.  If  he  deems  it  neces- 
sary, he  may  appoint  a  competent  inspector  to  investi- 
gate the  affairs  and  management  of  the  company.  The 
company  itself  may,  by  resolution  passed  at  the  annual 
meeting  or  at  a  special  meeting,  appoint  an  insiiector  for 
a  similar  purpose. 

Canadian  companies  are  not  unduly  bothered  with  re- 
quests for  official  statements.  The  directors  must  place 
before  the  shareholders  annually  *'a  full  printed  state- 
ment of  the  affairs  and  financial  position  of  the  com- 


WHERE   AND   HOW    TO   INCORPORATE        69 

l»imy."  Whenever  the  Secretary  of  State  asks  for  a 
rituni  containing  the  following-  particulars,  it  must  be 
made  by  the  company: 

(a)  The  amount  of  the  capital  of  the  company  and 
the  number  of  shares  into  which  it  is  divided. 

(b)  The  nmnber  of  shares  taken  from  the  commence- 
ment of  the  company  up  to  the  date  of  the  return. 

(c)  The  amount  of  calls  made  on  each  share. 

(d )  The  total  amount  of  calls  received. 

(e)  The  total  amount  of  calls  unpaid. 

(f )  The  total  amount  of  shares  forfeited. 

(g)  The  names,  addresses,  and  occupations  of  the 
]>ersons  who  have  ceased  to  be  members  within  the  twelve 
months  next  preceding,  and  the  number  of  shares  held 
by  each  of  them. 

44.  Ejctra-provincial  licensing  acts. — One  of  the 
serious  difficulties  in  company  incorporation  matters  in 
Canada  is  the  operation  and  effect  of  what  are  known 
as  the  extra-provincial  licensing  acts.  These  are  in  force 
in  the  various  provinces  in  Canada.  Generally  speaking, 
these  laws  require  companies  incorporated  outside  the 
j)rovince  enacting  the  law,  to  comply  with  certain  condi- 
tions and  pay  certain  fees  before  l>eing  allowed  to  carry 
on  business  in  the  province.  Default  in  these  matters  is 
met  with  penalties.  In  most  of  the  Canadian  provinces, 
these  extra-provincial  acts  apply  not  only  to  companies 
incorporated  under  the  Dominion  Act,  but  also  to  those 
incorporated  in  other  Canadian  i)rovinces  or  in  foreign 
jurisdictions.  These  conditions  naturally  complicate  the 
incorjwration  of  companies  in  Canada  and  undoubtedly 
interfere  considerably  with  the  business,  trade  and  com- 
merce of  the  Dominion.  The  question  as  to  the  rights 
f  the  nine  provincial  and  the  Dominion  governments  in 
the  matter  of  company  control  has  been  before  the  courts 


<) 


70 


CORPORATIOX    FINANCE 


i  t 


of  C  anada  for  many  years,  and  there  seems  little  likeli- 
lio(M  of  an  early  deeision  l>etueen  the  two  parties. 

The  formalities  neeessary  to  seeure  authorization  un- 
der the  various  aets  vary  Mith  the  provinces.  In  some 
o  the  provuiees,  the  authorization  is  obtained  by  a 
license  ;  ,n  others,  it  is  secured  by  ''registration."  In 
ail  the  provu.ces,  the  administration  of  the  acts  is  in  the 
hands  of  the  government  department  that  administers 
the  C  ompanies'  Act,  and  the  procedure  is  similar  to  that 
m  issuing  a  charter. 

As  the  corporation  laws  of  Canada  stand,  it  is  unwise 
for  company  promoters  to  proceed  with  the  business  of 
promotion  and   incorporation   without  the   senices   of 
reputable  Canadian  lawyers,  and  preferably  those  who 
are  accustomed  to  the  intricacies  of  the  various  acts 
An  exami)le  of  a  Dominion  charter  is  appended 
The  forms  of  charter  of  the  various  provinces  are 
somewhat  similar  to  that  of  the  Dominion 


AMERICAN  KITCHEN  PRODUCTS  COMPANY  OF  CAN- 
ADA, LIMITED 

Puyic  Notice  is  hereby  given  that  under  the  First  Part  of 
chapter  79  of  the  Revise.!  Statutes  „f  Canada,   1906,  known 
".s    1  he  C  ompanie.'  Act,"  letters  patent  have  heen  issued  under 
he  S..    of  the  Secreiary  of  State  of  Canada,  bearing  date  of 
tlie  90tl.  chiv  of  A.gust,   191JJ,   incorporating  Wilham  Jay 
Seh.effehn   an.I   Henry   Stevenson    Livingston,  merchants,   and 
Benjannn  Jonas  Weil,  real  estate  dealer,  of  the  City  of  New 
y.rk,  ,n  the  State  of  New  Y«rk,  one  of  the  United  States  of 
America    and  David   Charies   Robertson,  King's  counsel,  and 
I  harles  Lovelace  Buchanan,  accountant,  of  the  City  of  Mon- 
treal, ,n  the  Province  of  QueWc,  for  the  following  purposes. 
VIZ.:— (a)   To  manufacture,  purchase  and  sell  bouillon  cubes 


WHERE    AND    HOW    TO    INCORPORATE        71 


and  otiior  kinds  of  concentrated  food  protlucts;  (b)  To  purclinse, 
iii.'iMiifacture  untl  sell  any  raw  nmtcrial  used  for  the  manufacture 
of  such  cuIkjs  or  food  products;  (<•)  To  carry  on  the  huHincss 
of  niercliants  or  of  manufacturers'  agents  in  connection  with 
the  purchase  or  sale  of  such  cuhcs  or  food  products;  (rf)  To 
carry  on  the  business  of  warehousemen  f«)r  tJie  warehousing  of 
tlieir  own  products  or  those  of  others;  {c)  To  apply  for,  pur- 
chase or  otherwise  acquire  nny  patent  of  invention  or  secret 
process  useful  for  the  purposes  of  any  business  which  the  com- 
j)any  is  authorized  to  carry  on ;  (f)  To  sell  out  the  undertaking 
of  the  company,  in  whole  or  in  part,  for  such  consideration  as 
the  company  may  deem  fit,  and  in  particular  for  shares,  de- 
luiitures  or  securities  of  any  other  company  having  objects 
similar,  in  whole  or  in  part,  to  those  of  this  company,  notwith- 
standing the  provisions  of  section  44  of  the  said  Act,  and  to 
provide  by  by-law  the  manner  in  which  the  directors  may  be 
iiuthorized  to  make  such  a  sale;  (fr)  To  acquire  the  good-will, 
rights  and  property  of  an}'  kind,  and  to  acquire  and  undertake 
the  whole  or  any  part  of  the  assets  and  liabilities  of  any  person, 
firm,  association  or  corporation  having  powers  similar  to  those 
of  this  company,  and  to  pay  for  the  same  in  cash,  stock  or 
bonds  of  this  corporotion  or  otherwise;  (h)  To  amalgamate 
with  any  company  having  powers  similar  to  those  of  this  com- 
pany, upon  such  terms  and  conditions  as  may  be  agreed  upon ; 
(J)  To  acquire  by  purchase,  subscription  or  otherwise,  and  to 
hold,  sell  or  otherwise  dispose  of  shares,  stocks,  bonds  or  obli- 
gations of  any  company  having  objects  similar,  in  whole  or  in 
part,  to  those  of  this  company,  notwitlistanding  the  provisions 
of  section  44  of  the  said  Act,  and  to  vote  thereon  as  owners 
thereof;  (j)  To  invest  and  deal  with  the  moneys  of  the  company 
not  inntie«liately  require<l  in  such  manner  as  from  time  tc  time 
may  be  determined;  (k)  To  acquire  from  time  to  time  iand  and 
to  erect  such  buildings  thereon  as  may  be  thought  necessary 
for  the  purposes  of  the  company,  and  to  lease,  sell  or  otherwise 
dispose  thereof.  The  operations  of  the  company  to  be  carried 
on  throughout  the  Dominion  of  Canada  and  elsewhere  by  the 


72 


CORPORATIOX    FINAXCE 


name  of  "American  Kitehen  Prclucts  Company  of  Canarl^ 
into  300  .shares  of  one  hundre.1  dollars  each,  an,l  the  chief  place 

THOMAS  MULVEY, 

Under-Secretary  of  State. 


CHAPTER  V 


CORPORATE  3TOCK 

45.  Stock  certificates  not  fully  negotiable.— As  has 
already  been  said,  corporate  stock  is  not  a  tangible 
tiling;  it  is  simply  a  right  to  share  under  certain  limita- 
fions  in  the  management,  the  assets  and  the  earnings  of 
the  issuing  corporation.  Stock  is  represented  by  certifi- 
cates, which  are  in  possession  of  the  owners.  These 
certificates,  however,  it  must  not  be  forgotten,  are 
merely  evidence,  not  proof,  of  the  ownership  of  stock, 
/actual  ownership  is  proved  by  reference  to  the  books  of 
the  company  in  which  the  names  of  the  stockholders 
and  the  number  of  shares  held  by  each  one  are  entered. 
Certificates  of  stock  are  not,  therefore,  strictly  speaking, 
negotiable  instruments,  but  quasi-negotiable — a  term 
which  the  reader  will  find  defined  in  the  volume  on 
Commercial  Law. 

The  question  as  to  whether  stock  certificates  ought  to 
he  made  negotiable  or  not  has  been  much  agitated, 
especially  among  lawyers.  A  committee  of  the  Commis- 
sion on  Uniform  State  Laws,  which  is  a  body  of  lawyers 
appointed  by  the  governors  of  forty-one  states,  issued 
a  report  in  :March,  1909,  strongly  advocating  amend- 
ments to  existing  laws  which  would  make  transfer  of 
o\\  nership  of  corporate  stock  complete  on  delivery  of 
(iidorsed  certificates  of  stock  without  waiting  for  the 
formal  transfer  on  the  books  of  the  corporation;  in 
other  words,  the  proposed  amendments  would  make 
certificates  of  stock  true  negotiable  instruments.    The 

78 


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(Mb)   288  -  M89  -  Fq, 


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CORPORATION  FINANCE 


Important  sections  of  the  text  of  the  proposed  amend- 
ments are  as  follows : 

Section  1.  Title  to  a  certificate  and  to  the  shares  represented 
thereby  may  be  transferred : 

(a)  By  the  delivery  of  the  certificate,  if  indorsed  either  in 
blank  or  to  a  specified  person,  signed  by  the  person  appearing  by 
the  certificate  to  be  the  owner  of  the  shares  represented  thereby. 

(b)  By  delivery  of  the  certificate  with  a  written  assignment 
thereon,  or  a  power  of  attorney  to  sell,  assign,  or  transfer  the 
certificate  of  the  shares  represented  thereby  signed  by  the  per- 
son appearing  by  the  certificate  to  be  the  owner  of  the  shares 
represented  thercbj'.  Such  assignment  or  power  of  attorney 
may  be  either  in  blank  or  to  a  specified  person. 

The  provisions  of  this  section  shall  be  applicable  although 
the  charter  or  articles  of  incorporation  or  code  of  regulations 
or  by-laws  of  the  corporation  issuing  the  certificate  and  the  cer- 
tificate itself  provide  that  the  shares  represented  thereby  shall 
be  transferable  only  on  the  books  of  the  corporation  or  shall  be 
registered  by  a  registrar  or  transferred  by  a  transfer  agent. 

Section  17.  Nothing  in  this  act  shall  be  construed  as  for- 
bidding a  corporation  to  treat  as  owner  in  every  way  the  person 
who  may  be  registered  on  its  books  as  the  owner  of  shares. 

In  an  editorial  in  llic  Journal  of  Accountancy,  the 
writer  said  as  to  this  proposed  amendment: 

Accountants,  as  well  as  lawyers  and  business  men,  have  a  di- 
rect interest  in  this  proposition.  If  it  is  adopted  by  the  states 
in  which  numerous  corporate  charters  are  granted,  the  effects 
will  be  felt  in  many  different  forms.  Indeed,  it  is  doubtful, 
judging  from  their  explanatory  notes,  whether  the  commission- 
ers realize  what  an  extensive  reform  they  are  proposing.  At 
first  glance,  to  he  sure,  it  does  not  appear  that  any  considerable 
revision  of  present  practice  is  intended;  yet  the  act  plainly 
points  toward  passing  the  rights  and  privileges  of  stockholders 
along  with  transfers  of  stock  certificates. 

The  change  would  no  doubt  f^   ilitate  somewhat  the  purchase 


CORPORATE  STOCK 


,„d  sale  of  stock  by  removing  the  technical  requirement  that 
t,aMsfers  must  be  made  on  the  books  of  the  corporation  It 
would  enable  the  stock  exchange  brokers  to  carry  on  their  busi- 
ness more  easily  and  more  smoothly.  It  would  make  stock  cer- 
tificates more  acceptable  to  banks  as  collateral  for  loans.  These 
are  the  strongest  arguments  in  favor  of  the  act.  ,     ,    .    ^ 

On  the  other  side  of  the  question,  it  should  be  remarked  that 
nrvking  certificates  of  stock  fully  negotiable  subjects  them  to 
increased  danger  of  forgery,  theft  and  loss.     Many  peop  e,  no 
doubt,  would  prefer  the  comparative  safety  of  the  present  sys- 
t.,n,  just  as  many  investors,  when  a  choice  is  offered,  take  regis- 
tered rather  than  coupon  bonds.    This  is  a  point  of  considerable 
i„,portance.     A  far  stronger  argument  against  the  proposed 
measure,  however,  is  that  it  would  destroy  the  value  of  a  cor- 
poration's record  of  its  stockholders  and  would  thereby  foster 
fraud.    Accountants  are  only  too  familiar  with  cases  in  which 
corporations  are  organized  simply  for  the  purposes  of  transfer- 
ring property  from  one  hand  to  another  in  such  a  manner  as  to 
conceal  profits  or  to  swindle  creditors.     Under  the  present 
arrangement  it  is  generally  possible,  if  fraud  is  suspected,  to 
get  access  to  the  stockholders'  ledger  and  to  learn  who  are  the 
owners  of  the  corporation.    If  a  connection  botw-en  the  fomer 
owners  of  the  transferred  property  and  the  stockholders  of  the 
corporation  can  be  proven,  a  case  of  fraud  may  be  jnade  ou  ■ 
Under  the  proposed  arrangement  it  would  be  impossible  to  dis- 
cover the  tr'ue  owners  of  such  a  corporation     The  stockholders' 
ledger,  indeed,  might  be  kept,  but  it  would  be  of  small  value. 
The  certificates  of  stock,  and  consequently  the  ownership  of  the 
corporation,  might  change  hands  a  half  dozen  times  without 
nppearing  on  the  corporation's  books.    Numerous  similar  cases 
will  occur  to  any  accountant.  .     ,  .  ,  j  . „  .i,. 

We  do  not  wish  to  go  on  record  as  absolutely  opposed  to  this 
net.  We  have  no  doubt  that  it  would  be  a  convenience  to  cor- 
poration officials,  bankers  and  business  men  generally  if  stock 
certificates  were  made  fully  negotiable.  We  would  emphasize 
the  fact,  however,  that  this  provision  would  also  prove  a  great 
convenience  where  fraud  or  manipulation  is  intended.    It  would 


iii 


76 


CORPORATION  FINANCE 


' 


make  secrecy  as  to  corporate  ownership  even  easier  than  it  is 
now  and  would  tend  to  lessen  tlie  responsibility  that  ought  to 
attach  to  the  stockholders  of  corporations.  We  think  these  evils 
important  enough  to  outweigh  the  advantages  that  have  been 
named.  For  that  reason  we  suggest  that  the  law  with  regard  to 
transfers  of  stock  ought  to  be  left  unchanged  until  further  pro- 
vision has  been  made  for  pubicity  of  corporate  accounts  and  for 
detection  and  punishment  of  the  frauds  which  the  corporate 
form  already  too  much  favors.* 

46.  Par  vs.  market  value  of  stock. — Each  share  of 
stock  in  practically  every  case  has  a  nominal  money 
value.  The  most  common  nominal  value  of  each  share 
is  $100;  other  nominal  values  commonly  used  are  $50, 
$25,  $10  and  $1.  This  nominal  money  value  of  each 
share  is  sometimes  called  the  "par  value."  To  the  un- 
initiated the  par  value  of  stock  often  seems  quite  an 
important  matter.  They  are  apt  to  regard  it  as  being 
of  much  the  same  character  as  the  face  value,  say,  of  a 
promissory  note.  A  little  reflection,  however,  will 
readily  convince  anyone  that  there  is  no  close  analogy 
between  the  par  value  of  a  share  of  stock  and  the  face 
value  of  a  note,  and  that  the  par  value  of  a  share  throws 
very  little  light  on  the  actual  value  of  that  share. 

To  make  this  proposition  clear,  let  us  suppose  that 
three  oil  wells  are  discovered  by  three  different  individ- 
uals, the  three  wells  being  practically  identical  in 
location,  quality  of  oil  produced,  amount  of  flow,  per- 
manence, cost  of  operation,  access  to  markets,  and  other 
essential  attributes.  Each  of  the  owners,  we  will  say, 
interests  some  friends  and  outsiders  and  organizes  a 
corporation  to  work  his  well.  One  owner  is  extremely 
conservative  and  therefore  has  his  corporation  issue  only 
1000  shares  of  a  par  value  of  $1  per  share;  the  second 

T/ii-  Journal  of  .Iccounlancy.  March,  1909. 


CORPORATE  STOCK 


77 


IS 


,wner,  being  somewhat  more  sanguine,  thinks  his  well 
,s  worth  more  and,  therefore,  has  his  corporation  issue 
1000  shares,  each  of  a  par  value  of  $10;  the  third  owner 
is  blessed  with  a  vivid  imagination  which  leads  hmi  to 
Imve  his  corporation  issue  1000  shares,  each  of  a  par 
value  of  $100.    Now  what  will  be  the  actual  value  ot  a 
single  share  m  each  of  these  companies?     Obviously 
each  share  entitles  the  owner  to  ( ne  one-thousandth  of 
the  assets  and  earnings  of  the  well     As  the  wells,  ac- 
cording  to  our  supposition,  are  equally  profitable,  there 
will  be  no  difference  whatever  between  the  three  shares 
so  far  as  their  actual  values  are  concerned. 

Any  number  of  further  examples,  drawn  from  ex- 
perience, might  be  given  to  illustrate  this  truth.     In 
fact,  a  simple  inspection  of  the  prices  for  stock  bought 
and  sold  on  the  various  stock  exchanges  of  the  country 
is  sufficiently  convincing.    Most  of  the  shares  of  stock 
there  traded  in  have  par  values  of  $100;  their  market 
values  will  be  found  to  range  between  next  to  nothing 
and  $600  or  $700— sometimes  even  more  for  bank  stock. 
The  fact,  then,  that  a  certain  share  of  stock  has  a 
nominal  value  is  of  small  importance.     Its  practically 
valuable  attribute  is  its  right  to  a  certam  share  m  the 
corporation's  assets  and  earnings.    How  much  is  that 
share  to  be?    That  question  may  be  answered  simply 
bv  knowing  how  many  shares  of  stock  are  outstanding. 
If  a  corporation's  assets  are  worth  $1 ,00 WO  and  there 
are  1000  shares  in  the  hands  of  stockholders  we  know 
at  once  that  the  true  value  of  each  share  is  $1000  with- 
out reference  to  its  par  value. 

This  leads  us  to  a  question  which  was  brought  up 
several  years  ago  by  a  prominent  corporation  lawyer 

and  has  been  much  discussed.    "^^^^^  f'^f^lXl 
useless  par  values  and  make  each  share  m  form  as  it  is 


78 


CORPORATION  FINANCE 


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by  Secretary. 


CORPORATE  STOCK 


79 


in  practice  sknply  a  right  to  a  certain  percentage  of  the 
assets  and  earnings  of  the  issuing  corporation?     The 
form  of  a  certificate  of  stock  under  the  present  system  is 
given  on  page  70.    The  question  before  us  is  whether  it 
would  not  be  better  to  make  the  second  line  of  the  face  of 
the  certificate  read  instead  of  "Capital  Stock  $1,000,- 
000,"  "Number  of  shares  10,000,"  and  to  elimmate  the 
last  line,  "Shares  $100  each,"  altogether.     Logically 
there  could  be  no  objection  to  the  proposal;  each  share 
would  be  just  as  valuable— no  more  and  no  less— after 
the  change  as  before.     The  chief  advantage  gamed 
would  be  that  misconceptions  based  on  the  idea  that 
par  value  and  actual  value  in  some  way  correspond 
would  no  longer  be  possible. 

Although  this  reform  would  be  desirable,  and  is  now 
legally  permissible  in  New  York  and  in  some  other 
states,  it  is  not  very  seriously  advocated  and  probably 
will  never  be  adopted  simply  because  the  custom  of  as- 
signing a  nominal  money  value  to  each  share  has  become 
well  established  and  would  be  very  difficult  to  eradicate. 
The  same  object  will  be  attained  in  time,  as  people  be- 
come more  familiar  with  corporation  practice,  by  the 
general  recognition  of  the  obvious  fact  that  par  value 
and  actual  value  need  not  correspond;  that  the  earning 
power  of  each  share  is  the  real  test  of  value. 

47.  Nature  of  preferred  stock.-ln  most  corpora- 
tions all  the  stock  is  of  one  class  and  each  share  has  an 
equal  right  to  its  proportion  of  the  assets  and  earnings. 
Such  stock  is  called  "common"  because  no  share  has  any 
privileges  which  do  not  attach  to  all  the  other  shares 
In  general,  common  stock  may  be  defined  as  stock  which 
does  not  possess  any  special  or  peculiar  rights. 

Other  corporations,  however,  set  aside  certam  amounts 
of  stock  in  a  separate  class  and  grant  to  this  class  spe- 


80 


CORPORATION  FINANCE 


i: 


ilii' 


cific  privileges.  Such  stock  is  called  preferred.  The 
usual  preference  consists  in  giving  a  fixed  dividend 
to  the  stock  preferred  before  any  payment  whatever  is 
made  to  the  common  stock.  This  dividend  may  be 
"cumulative";  that  is,  if  profits  are  not  enough  to  pay 
it  in  full  in  one  or  more  years,  the  unpaid  portion  re- 
mains as  a  claim  against  earnings  that  must  be  settled 
before  any  payment  is  made  to  the  common  stock.  Or 
it  may  be  "non-cumulative";  that  is,  if  profits  in  any 
year,  including  usually  the  accumulated  profits  of  pre- 
ceding years,  are  insufficient  to  cover  the  preferred  stock 
dividend,  the  unpaid  portion  is  wholly  lost  to  the  pre- 
ferred stockholders,  no  matter  how  large  the  earnings 
in  succeeding  years  may  be.  Let  it  be  kept  clearly  in 
mind,  however,  that  preference  as  to  dividends  is  merely 
the  usual,  not  the  universal,  privilege  given  to  preferred 
stock.  When  the  single  statement  that  stock  is  "pre- 
ferred" is  made,  it  is  necessary  to  consult  the  charter  and 
by-laws  of  tlie  corporation  in  order  to  be  sure  as  to  the 
exact  nature  of  the  preference. 

The  stock  may  be  preferred  as  to  assets,  as  well  as 
dividends,  or  as  to  both.  Furthermore,  cumulative 
preferred  stock  may  get  a  fixed  dividend,  and  no  more, 
which  is  the  customary  arrangement;  it  may  get  a  fixed 
dividend  and  then,  after  the  common  stock  has  secured 
a  fixed  dividend,  all  the  rest  of  the  earnings  may  be 
divided  equally  between  the  two  stocks,  which  is  the 
arrangement  presumed  by  law  unless  an  expressed  stip- 
ulation to  the  contrary  is  contained  in  either  the  charter 
or  by-laws;  or  it  may  get  a  fixed  dividend  and  the  com- 
mon stock  a  fixed  dividend  and  all  the  rest  of  the  earn- 
ings may  then  go  to  the  preferred  stock,  which  is  a 
very  unusual  arrangement. 

Preferred  stock  had  its  origin  in  railroad  reorganiza- 


CORPORATE  STOCK 


81 


tions.  In  reorganization  after  bankruptcy  it  is  neces- 
sary to  cut  down  the  claims  of  the  various  bond  issues 
outstanding  in  order  to  put  the  reorganized  corpo- 
ration in  a  reasonably  safe  condition.  The  interest 
on  the  first  mortgage  bonds  is  usually  scaled;  some  of 
the  junior  issues  are  perhaps  turned  into  income  bonds; 
and  in  the  seventies  some  bright  mind  conceived  the  idea 
of  changing  the  inferior  bond  issues  into  preferred 
stock.  This  process  will  be  explained  much  more  fully 
in  our  discussion  of  bankruptcy  and  reorganization. 

48.  Uses  of  preferred  stoch— Although  preferred 
stock  was  originally  the  offspring  of  receiverships,  it 
proved  to  be  such  a  useful  instrument  for  some  purposes 
that  it  has  been  retained  and  is  now  much  used,  especially 
by  industrial  companies.  The  railroad  companies,  for 
reasons  that  will  be  later  discussed,  are  gradually  giving 

it  up. 

Apart  from  its  usefulness  already  alluded  to  in  cases 
of  reorganization,  preferred  stock  serves  four  other 
purposes.  First,  it  may  be  a  convenient  means  of 
separating  a  company's  stock  into  different  voting 
classes.  Sometimes  the  preferred  stock  has  no  vote  at 
all;  sometimes  it  elects  a  limited  number  of  directors. 
In  either  case  the  owners  of  the  majority  of  the  common 
stock  may  elect  a  majority  of  the  board  of  directors. 
Therefore,  a  much  smaller  interest  will  control  the 
business  than  would  be  necessary  if  all  the  stock  issued 
voted  alike. 

Second,  preferred  stock  is  often  very  useful  in  form- 
ing industrial  consolidations.  As  we  shall  see  in  the 
study  of  these  consolidations,  they  are  usually  capitalized 
for  a  great  deal  more  than  the  combined  capitalization 
of  their  subsidiary  companies.  Ordinarily  the  extra 
capitalization,  which  represents  prospects,  takes  the  form 

C— VI— 6 


.■/T// 


82 


CORPORATION  FINANCE 


rf 


i.ii 


of  common  stock,  and  the  present  value  of  the  plants 
and  businesses  absorbed  is  represented  by  bonds  and 
preferred  stock.  The  subsidiary  company  stockholders 
are  much  more  inclined  to  exchange  their  common 
stock  for  preferred  stock  in  the  consolidation  than  they 
would  be  to  exchange  for  common  stock.  If  the  sub- 
sidiary businesses  have  been  successful  and  profitable 
it  is  reasonable  to  expect  that  dividends  on  the  preferred 
stock  can  be  paid,  whereas  nobody  can  foresee  whether 
common  dividends  will  be  paid  or  not. 

The  third  purpose  of  preferred  stock  is  to  facilitate 
the  incorporation  of  a  business  which  has  been  conducted 
as  a  partnership.  In  a  partnership  each  partner  has  as 
much  say  with  regard  to  affairs  as  any  other  partner, 
irrespective  of  the  extent  of  his  interest.  It  is  true  that 
in  practice  the  senior  partner  usually  controls,  but  in  law 
they  are  all  on  the  same  footing.  They  may  desire  to 
preserve  the  same  arrangement  in  the  corporation,  in 
which  case  they  may  create  a  non-voting  common  stock 
and  assign  that  stock  to  each  partner  in  proportion  to  his 
interest  in  the  partnership  and  in  addition  may  make  a 
voting  preferred  stock,  of  which  each  partner  receives 
an  equal  amount.  In  this  case  it  is  possible  that  the  so- 
called  preferred  stock  may  have  preference  in  nothing 
except  voting  power. 

Fourth,  preferred  stock  obviously  may  attract  con- 
servative investors  who  would  not  care  to  buy  the  more 
speculative  common  stock  of  a  corporation.  Preferred 
stock,  in  point  of  security,  ranks  between  the  lower 
grades  of  bonds,  which  are  described  in  succeeding  chap- 
ters, and  common  stock.  The  preferred  stock  of  indus- 
trial corporations,  on  account  of  their  fluctuating  earn- 
ings, usually  sells  at  much  better  prices  than  the  common 
stock  of  the  same  corporations,  even  though  the  common 


CORPORATE  STOCK  »» 

stock  may  receive  on  the  average  as  large  or  larger 

dividends.  ,      .„  ,        .      -j^ 

Sometimes  a  certain  amount  of  stock  will  be  set  aside 
at  the  organization  of  a  corporation  and  given  voting 
power,  which  right  is  denied  to  all  the  other  stock.  In 
such  a  case  the  corporation  has  in  existence  two  classes  of 
stock,  "voting"  and  "non-voting."  This  is  not  at  all  a 
.ommon  arrangement  and  is  rarely,  if  ever,  adopted  ex- 
cept when  a  partnership  business  is  put  into  the  corpo- 
rate form.  It  amounts  to  the  same  thing  as  creating 
preferred  stock  with  the  preference  confined  to  the  privi- 
lege of  voting.  , 

49.  Cumulative  voting. -OvigmaWy  the  universal  cus- 
tom as  to  the  voting  power  of  corporate  stock  was  to  give 
ore  vote  to  each  share.  The  custom  is  still  general,  at 
least  so  far  as  common  stock  is  concerned  but  is  no 
longer  universal.  Certain  important  modifications  of 
the  custom,  which  have  become  more  and  more  popular, 

should  be  noted.  .    -u  i.  •* 

The  chief  objection  to  ths  origmal  custom  is  that  it 
puts  the  control  of  the  corporation  absolutely  m  the 
hands  of  the  owners  of  the  majority  of  the  stock.  Under 
this  custom  they  elect,  not  merely  the  majority,  but 
all  of  the  members  of  the  board  of  directors.  Hence  the 
minority  stockholders  may  find  themselves  unrepre- 
Tented  and  absolutely  powerless.  This  is  unfortunately 
the  condition  of  the  minority  in  almost  all  American 
corporations.  . 

In  order  to  provide  to  some  extent  against  this  ac- 
knowledged  evil  and  the  abuses  which  are  likely  to  fol- 
low,  it  is  very  common  in  England  to  restrict  the  number 
of  ;otes  allowed  to  any  one  stockholder.  Thus  a  man 
with  ten  shares  or  less  may  be  allowed  one  vote  for  each 
share ;  for  each  additional  share  up  to  twenty  he  may  get 


84 


CORPORATION  FINANCE 


If 
t, 

ir. 


#1! 


only  one-half  of  a  vote ;  for  each  additional  share  up  to 
forty  he  may  get  only  one-quarter  of  a  vote,  and  so  on. 
As  each  company  prescribes  in  its  by-laws  its  own  rules 
as  to  voting,  there  are  naturally  a  great  many  variations 
of  this  arrangement.  The  object  evidently  is  to  give  the 
great  body  of  small  stockholders  a  voice  in  the  manage- 
ment of  the  company  and  to  make  it  impossible  for  any 
individual  or  small  clique  to  gain  absolute  control  with- 
out owning  all  or  nearly  all  the  capital  stock.  At  first 
glance  this  arrangement  seems  admirable.  It  would  be 
so  easy,  however,  for  a  large  stockholder  to  have  his 
stock  transferred  in  small  lots  to  various  employees  and 
members  of  his  family,  and  thus  retain  full  voting  power 
for  that  stock,  that  it  is  certain  that  the  principle  could 
never  be  made  to  work  effectively  under  American  con- 
ditions. The  only  reason  that  it  is  moderately  success- 
ful in  England  is  that  stock  is  o  i  the  whole  more  widely 
scattered  and  held  in  smaller  lo':s  than  in  this  country. 

A  far  more  effective  method  of  attaining  the  same 
end  is  "cumulative  voting."  Under  this  method  each 
share  has  as  many  votes  in  electing  directors  as  the  num- 
ber of  directors  to  be  chosen.  These  votes  may  be 
scattered  among  the  nominees  or  concentrated  on  one  or 
two  of  them  as  the  stockholder  sees  fit.  The  eftect  is  to 
make  it  impossible  for  a  majority  to  elect  all  the  board; 
the  minority  at  least  secures  representation. 

To  illustrate  the  working  of  this  method,  take  a  cor- 
poration in  which  tliere  are  lOOC  voting  shares  and  five 
members  of  the  board  of  directors  to  be  elected;  each 
share,  then,  is  entitled  to  five  votes.  We  will  suppose 
that  there  is  an  organized  majority  of  550  shares  and  an 
organized  minority  of  450  shares.  Under  the  usual  ar- 
rangement a  majority  vote  would  be  cast  for  five  nom- 
inees, all  of  which  would  represent  the  majority  stock- 


CORPORATE  STOCK 


85 


lioldcs, 
u 


Under  the  cumjJative  voting  system,  however, 
oaci      '-re  having  five  votes,  the  majority  would  cast 
altogether  2,750  votes  and  the  minority  2,250.     The 
majority  could  safely  give  91G  2-3  votes  to  each  of  tliree 
nominees  and  thus  elect  a  majority  of  the  board,  leaving 
tlie  other  two  directors  to  be  elected  by  the  2.250  votes  of 
tlie  minority.    But  if  the  majority  should  attempt  to 
elect  four  directors  they  could  give  only  6871/2  votes  to 
each  of  the  four,  whereas  the  minority,  if  well  organized, 
could  concentrate  their  votes  on  three  directors  and  give 
each  one  750  votes,  thereby  electing  a  majority  of  the 
board.    To  make  the  system  and  its  possibilities  per- 
fectly clear,  it  would  be  well  for  each  reader  to  construct 
mentally  a  number  of  similar  hypotl  ^tical  cases  and  to 
observe  how  readily  a  minority  under  this  system  may 
secure  control  of  the  board  of  directors,  if  the  majority 
stockholders  are  too  greedy. 

Cumulative  voting  is  an  ingenious  and  generally  a 
highly  desirable  method  of  conducting  corporate  elec- 
tions. As  was  stated  once  before,  the  constitution  of 
Pennsylvania  contains  a  clause  requiring  that  all  corpo- 
rations organized  under  the  laws  of  that  state  shall  con- 
duct their  elections  by  the  cumulative  voting  method. 
Opinions  may  differ  as  to  the  propriety  of  includmg 
snnh  a  provision  in  a  state  constitution.  There  can 
hardly  be  a  doubt,  however,  as  to  the  wisdom  of  putting 
it  into  the  charters  of  most  corporations. 

50.  Voting  trusts.— Another  method  of  protecting  the 
interests  of  minority  stockholders  and  of  the  creditors 
of  a  corporation  is  the  formation  of  a  voting  trust,  i  his 
is  an  agreement  under  which  a  majority  of  the  voting 
stock  of  a  corporation  is  placed  in  the  hands  of  trustees 
who  are  authorized  to  vote  it  under  whatever  limitations 
may  be  prescribed.    The  trustees  usually  issue  m  return 


86 


CORPORATION  FINANCE 


if 


:| 


I 


for  the  stock  so  deposited  "voting  trust  certificates," 
which  certify  that  the  stock  is  held  in  trust  by  the  trus- 
tees and  which  may  be  sold  and  transferred  in  the  same 
manner  as  certificates  of  stock.  As  the  trustees  are 
usually  men  of  high  standing  who  are  under  instructions 
to  vote  the  stock  for  certain  officials  or  in  behalf  of  cer- 
tain measures,  the  minority  stockholders  may  safely  feel 
that  so  long  as  the  agreement  exists  no  radical  change 
in  the  policy  of  the  corporation  can  take  place,  and  the 
rights  of  all  stockholders  alike  will  be  respected. 

A  voting  trust  agreement  which  seriously  restricts  the 
freedom  of  the  majority  stockholders  of  a  corporation 
is,  of  course,  not  likely  to  be  acceptable  to  those  stock- 
holders. The  agreement,  therefore,  as  might  be  ex- 
pected, is  not  often  made  except  under  strong  pressure. 
It  is  most  frequently  used  either  when  a  corporation  is 
first  formed  and  can  secure  additional  capital  on  no  other 
terms;  or  when  a  corporation  is  in  financial  difficulties 
and  its  creditors  are  in  a  position  to  demand  that  the 
management  be  intrusted  to  certain  men  and  that  a  well- 
defined  policy  be  pursued. 

61.  History  of  a  large  Canadian  holding  company. — 
The  most  notable  example  of  recent  years  of  the  forma- 
tion of  a  holding  company  in  Canada  was  that  of  the 
Dominion  Steel  and  Coal  Corporation,  Limited.  This 
concern  was  incorporated,  issued  new  stock,  and  them 
controlled  both  the  Dominion  Iron  and  Steel  Company 
and  the  Dominion  Coal  Company,  formerly  separate 
corporations.  The  history  of  this  transaction  is  interest- 
ing and  illustrates  many  of  the  principles  enunciated  in 
this  volume.  It  is  necessary  to  consider  it  briefly,  as 
leading  up  to  the  foundation  of  a  holding  company  to 
control  two  corporations  which  were  previously  fighting 
in  the  law  courts. 


CORrORATE  STOCK 


87 


Dominion  Coal  Company  was  incorporated  and  began 

""oSon^irand  SUel  Company  was  organi^d 
i„  mTrny  directors  being  also  directors  of  the  coal 

Teel'company  erected  works  and  began  to  operate 

'"  S  Company  entered  into  contract  with  Coal  Com- 

nanv  for  supply  of  coal  at  $1.20  per  ton. 

■^  Steel  Company  took  lease  of  Coal  Company  m  1902. 

•  ;„,lv  rental  of  $1,600,000  and  royalty  of  lo 
S^r  t^  <-.  U  ll  nJn;d  exceeding  8  500,000  tons. 
"teaCtermTnated  in  1903.  and  Coal  Company  as- 
sumed  full  control  of  its  own  property. 

Ccl  Company  agreed  on  October  ^O.^^^^J^'^^ 
nish  Steel  Company  with  all  coal  required  at  $1.24  per 
ton,  with  four  cents  per  ton  for  use  of  ca«. 

Steel  Company,  having  choice,  asked  tor  cod  from 

^  Tte  rZ^nt  to  Stee.  Company  and  found  to  conUin 
too  Lh  gr^e  of  sulphur  for  steel  manu  acture  was 
r^eafd  a^d  frequently  taken  back  by  Coal  Company. 
St^  Company  notified  Coal  Company  that  coal  was 

TtS'company  agreed  to  accept  without  preju^« 
,0  rights  under  contract.  75  tons  per  day  of  rejert^  coal. 
Proposal  was  agreed  to  by  Coal  Company  and  the  ar- 
ranjtement  continued  for  some  months. 

C»T  Company  in  1905-6  failed  to  supply  the  Ml 
coal  requirements  of  the  Steel  Company,  except  m  wm- 

'"s^fcompany  notified  Coal  Company  on  March  80 
,905>.tt^«u«  of  increased  work  80,000  tons  of  coal 
would  be  required  in  April.  1906. 


88 


CORPOKATIOX  FINAxVCE 


mn 


Coal  Company  replied:  "We  shall  endeavor  to  pre- 
pare to  meet  your  increased  requirements." 

Steel  Company  gave  notice  on  April  30,  1906,  of 
80,000  tons  of  coal  for  August,  September  and  October, 
1906,  respectively. 

Coal  Company  supplied  only  58,270,  50,525  and  62,- 
618  tons  respectively. 

Steel  Company  was  compelled  to  purchase  19,000  tons 
elsewhere  to  operate  works. 

Steel  Company  having  agreed  to  accept  without 
prejudice  to  contract  rights,  slack  coal  and  banked  coal, 
so  as  to  receive  sufficient  coal,  and  Coal  Company  failing 
to  deliver  right  quantity.  Steel  Company  notified  they 
would  not  accept  any  coal  except  from  Phelan  seam, 
which  coal  was  satisfactory. 

After  November  1,  1906,  Coal  Company's  cars  sent 
to  Steel  Company  were  labelled  "Run  of  Mine,  Phelan 
Seam,"  while  previously  cars  were  labelled  indicating  pit 
from  which  coal  was  taken. 

Steel  Company  analyst  was  thus  compelled  to  ana- 
lyze coal,  and  found  much  of  it  unfit  for  steel  manufac- 
turing.   Sleel  Company  rejected  this  coal. 

Coal  Company  gave  notice  of  termination  of  contract 
on  ground  that  Steel  Company  had  made  a  breach  by 
refusing  the  coal. 

Steel  Company  closed  woi-':s  about  November  9, 1906, 
until  coal  could  be  procured  elsewhere. 

A  temporary  contract  was  made  between  Steel  and 
Coal  Companies  for  supply  of  coal  at  a  price  much 
higher  than  that  specified  in  contract  of  October  20, 
1908. 

Judge  Longley  decided  dispute  in  favor  of  Steel  Com- 
pany on  September  10,  1907. 

Coal  Company  lodged  appeal  with  Privy  Council. 


CORPORATE  STOCK 


89 


Coal  and  Steel  interests  met  in  Toronto  to  endeavor 
to  arrange  a  settlement,  April  15,  1908. 

December  1,  consolidated  appeal  of  the  Dominion 
Coal  Company  opened  before  judicial  committee  of 
Privy  Council.  Privy  Council  gave  judgment  in  favor 
of  the  Steel  Company. 

The  conclusion  of  the  Privy  Council's  decision  reads: 

Inasmuch,  however,  as  according  to  their  Lordships'  view, 
this  is  not  a  contract  of  which,  on  the  authorities  cited,  specific 
performance  woiSd  be  decreed  by  a  court  of  equity,  the  plain- 
tiffs arc  entitled,  owing  to  a  wrongful  repudiation  of  the  con- 
tract by  the  defendants,  to  treat  the  contract  itself  as  at  an 
end,  and  recover  damages  for  the  loss  of  it,  in  addition  to 
damages  in  respect  of  those  breaches  of  it  which  may  have  been 
committed  before  repudiation,  namely,  to  the  31st  of  October, 
1906.     A  proper  reference  should,  their  Lordships  think,  be 
directed  to  ascertain  these  damages.     Their  Lordships  there- 
fore humbly  advise  that  the  judgment  of  the  Supreme  Court 
be  affirmed,  and  that  the  case  should  be  remitted  to  the  court 
to  have  the  damages  under  the  two  heads  above  mentioned 
assessed  in  the  usual  way,  the  appellants  to  pay  the  costs  of 
tlie  principal   appeal.     No  order  as   to  costs  or  the  cross 
appeal. 

Judge  liongley  of  the  Supreme  Court  of  Nova  Scotia 
ruled,  it  will  be  remembered,  that  the  old  contract  was 
unbroken;  that  the  Coal  Company  must  perform  the 
contract,  a  referee  to  be  appointed  to  assess  the  damages 
payable  by  the  Coal  Company;  that  the  damages  should 
iiidude  all  the  amounts  the  Steel  Company  had  paid  for 
coal  over  and  above  $1.24  a  ton:  that  the  coal  supplied 
from  No.  6  mine  was  unfit  for  the  uses  of  the  Steel  Com- 
pany: that  if  the  Coal  Company  attempted  to  evade 
l)crformance  of  the  contract,  the  court  had  power  to  ap- 
])oint  a  receiver. 


90 


CORPORATION  FINANCE 


6  i 


5J    H 


h: 


The  Steel  Company  was  entitled  to  damages  for  the 
loss  of  its  contract  with  the  Coal  Company  and  to  dam- 
ages for  breaches  of  the  contract  before  repudiation  by 
Coal  Company.  The  Steel  Company's  claim  of  dam- 
ages against  the  Coal  Company  up  to  May  31,  1909, 
was  as  follows: 

Paid   for  extra   cost   of   coal   purchased   from 

l")oininion  Coal  Company $1,847,550.18 

Pav'.   for   extra   cost    of  coal   purchased    from 

others 465,005.76 

Damages    due    to    short    deliveries    in    August, 

September  and  October,  1906 132,252.75 

Damages  due  to  cessation  of  deliveries  in  No- 
vember, 1906  (estimated) 479,000.00 

$2,928,808.69 

The  Privy  Council,  in  London,  England,  the  final 
court  of  appeal,  in  February,  1909,  gave  judgment  in 
favor  of  the  Steel  Company.  So  far  as  legal  rulings 
were  concerned,  the  case  was  at  an  end. 

The  next  thing  known  to  the  public  was  that  after 
this  lengthy  corporation  battle,  the  two  companies  pro- 
posed to  unite  interests,  a  very  sensible  decision.  Mr. 
James  Ross,  president  of  the  Coal  Company,  agreed  to 
sell  to  a  syndicate  50,000  shares  of  Dominion  Coal  com- 
mon stock  at  $95  per  share.  Thus  he  made  his  exit. 
Other  shareholders  who  desired  were  given  an  opportu- 
nity to  sell  their  coal  holdings  on  the  same  terms.  Of 
that  price,  $25  per  share  was  payable  in  cash  within 
thirty  days  and  ten  instalments  of  $7  each  per  share  at 
intervals  of  three  months  during  a  period  of  two  and  a 
half  years,  with  interest  at  the  rate  of  4V^  per  cent, 
payable  quarterly.    This  paved  the  way  for  those  share- 


CORPORATE  STOCK 


91 


liolders  who  did  not  desire  to  remain  as  shareholders 
under  control  of  the  new  holding  comptiay.  Compara- 
tively few  holders  sold  their  shares. 

There  then  remained  the  question  of  the  union  of  the 
companies.    After  the  formation  of  the  Dominion  Steel 
and  Coal  Corporation,  the  holding  company,  it  was 
agreed  that  Steel  and  Coal  shares  should  go  in  on  the 
slnie  basis,  holders  of  either  having  the  privilege  of  ex- 
changing them  for  an  equal  number  in  the  new  concern. 
A  payment  of  $4  in  cash  was  made  to  the  holders  of  each 
share,  in  amounts  of  $1,  payable  quarterly,  beginnmg 
July  1,  1910.    This  payment  in  cash  was  equivalent  to 
a  dividend  of  4  per  cent  per  annum  for  one  year, 
and  while  forming  part  of  the  purchase  price,  was  in- 
tended to  obviate  any  call  on  either  company  for  divi- 
dends until  the  coal  strike  and  its  effects  had  passed 
away,  and  the  new  plant  of  the  Steel  Company  was  com- 
pleted.   The  surplus  earnmgs  meantime  were  used  to 
strengthen  the  financial  position  of  the  two  companies 
and,  so  far  as  they  were  used  for  permanent  improve- 
ments, lessened  the  amount  of  securities  they  might 
otherwise  issue.    So  did  two  warring  corporations  be- 
come united  in  peaceful  industry. 

The  total  capital  of  the  new  company  remained  the 
same  as  the  aggregate  capital  of  the  two  individual  com- 
I)anies.  Here  is  a  table  showing  the  amount  of  the  out- 
standing securities  of  the  two  companies  as  at  Decem- 
l)er  20,  1909: 

Authorized 
Common        Pfd.  7%       Bonds  6% 
Dominion  Iron  &  Steel ..  $20,000,000  $5,000,000  $20,000,000 
Dominion  Coal  Co 13,000,000     3,000,000       7,500,000 


Total $85,000,000  $8,000,000  $27,500,000 


92 


CORPORATION  FINANCE 


Outstanding  Securities 
Dominion  Iron  &  Steel.  .$20,000,000  .$5,000,00C  $18,000,000 

Dominion  Coal 15,000,000     3,000,000       6,175,000 

Total $35,000^000"  $8^00o7)00  $24,429,000 

The  second  mortgage  bonds  have  been  retired,  and  at 
the  beginning  of  1910,  out  of  the  $8,000,000  authorized 
issue  of  first  mortgage  5  per  cent  bonds,  only  $7,414,- 
000  were  outstanding.  The  company  had  issued  $10,- 
840,000  of  its  twenty  million  authorized  consolidated 
bonds. 

The  official  announcement  of  the  arrangement  and 
damage  settlement  was  made  in  the  few  words  following 
by  Mr.  J.  H.  Plummer,  president  of  the  Steel  Com- 
pany, and  now  president  of  the  holding  company,  the 
Dominion  Steel  and  Coal  Corporation: 

In  December  last  your  directors  found  themselves  in  a  posi- 
tion to  acquire  at  par  50,000  shares  of  the  common  stock  of 
the  Dominion  Coal  Company,  Limited,  under  circumstances 
which  in  their  opinion  made  their  purchase  a  great  advantage 
to  the  company.  The  purchase  was  accordingly  completed, 
and  your  directors  have  agreed  to  exchange  the  shares  for 
shares  in  the  Dominion  Steel  and  Coal  Corporation,  Limited. 
By  the  formation  of  this  corporation,  the  interests  of  the  Coal 
and  Steel  Companies  are  practically  merged,  to  their  common 
advantage. 

Following  on  the  purchase  of  the  shares,  several  of  your 
directors  joined  the  board  of  the  Coal  Company,  and  the  presi- 
dent and  general  manager  of  this  company  became  president 
and  general  manager  of  the  Coal  Company  as  well. 

The  outstanding  claim  against  the  Coal  Company  for  dam- 
ages, on  account  of  which  .$2,750,000  was  received  in  March, 
1909,  has  been  settled  by  payment  of  a  further  sum  of  $800,000. 
This  payment  covers,  in  addition  to  the  damages,  several  other 
claims  which  have  been  in  dispute  for  many  years,  and  operates 
as  a  settlement  of  all  outstanding  accounts  between  the  two 
companies. 


CHAPTER  VI 

TYPES  OF  BUSINESS  CORPORATIONS 

52.  Further  classification  of  corporations.— So  far, 
our  only  classification  of  corporations  has  been  into  the 
two  groups,  stock  and  non-stock.  The  non-stock  cor- 
poration, as  has  been  said,  is  adapted  only  for  govern- 
mental, social,  eleemosynary,  educational  or  religious  in- 
stitutions, and  not  to  business  concerns,  the  prime  reason 
being  that  the  absence  of  stock  leaves  no  machinery  for 
obtaining  capital,  except  borrowing,  or  for  distributing 
profits.  We  have,  therefore,  dismissed  the  non-stock 
corporations  as  being  altogether  outside  the  scope  of  this 

volume. 

Stock  corporations  may  be  further  classified  as  quasi- 
public  and  private.    Quasi-public  corporations  are  those 
which  perform  a  service  for  the  whole  community  for  the 
sake  of  profits  to  the  owners  of  the  corporation.    The 
most  conspicuous  examples  are  steam  and  electric  rail- 
roads, water  companies,  gas  and  electric  light  companies 
and  telephone  and  telegraph  companies.    Quasi-public 
corporations  are  granted  special  franchises  and  powers, 
such,  for  instance,  as  the  right  of  eminent  domain,  and, 
on  the  other  hand,  are  peculiarly  subject  to  legislative 
control.    Private  corporations  are  those  which  carry  on 
imy  business,  such  as  manufacturing,  trading,  and  so 
on,  without  having  any  special  franchise,  entirely  for 
the  sake  of  profits  to  their  owners.    The  great  majority 
of  corporations  belong  in  this  second  classification. 
We  may  further  classify  this  last  group  on  the  basis 

93 


94 


CORPORATION  FINANCE 


t 


if 


of  number  of  owners  into  "close"  and  "open"  corpora- 
tions. Close  corporations  are  those  in  which  the  shares 
of  stock  are  held  by  a  very  small  number  of  people  who 
do  not  expect  to  transfer  them.  Such  corporations  are 
not  much  in  the  public  eye,  since  their  affairs  are  of 
interest  to  only  a  few  individuals.  Frequently  a  "family 
business,"  which  has  been  organized  as  a  kind  of  loose 
partnership  for  many  years,  is  turned  into  a  corporation 
and  none  but  members  of  the  family  are  stockholders  in 
the  corporation.  Sometimes  estates  are  put  by  execu- 
tors into  the  corporate  form  for  ease  in  transferring  in- 
terests and  in  making  the  complicated  adjustments  at- 
tendant upon  the  settlement  of  a  large  estate.  These  are 
typical  instances  of  the  close  corporation.  By  an  open 
corporation  is  meant  one,  the  shares  of  which  are  held  by 
a  considerable  number  of  individuals  and  are  traded  in 
more  or  less.  It  is  called  open  because  anyone  who  has 
the  money  may  readDy  buy  some  of  its  shares.  Most 
business  corporations  belong  in  this  class. 

We  shall  have  occasion  frequently  in  this  volume  to 
refer  to  both  "large"  and  "small"  corporations.  These 
words,  of  course,  have  no  absolute  meaning;  yet  in  con- 
nection with  corporations  a  fairly  definite  distinction 
between  them  may  be  drawn.  Generally  speaking,  when 
large  corporations  are  mentioned  we  shall  have  in  mind 
the  companies  which  operate  several  different  plants  or 
rail  lines,  particularly  the  big  railroad  consolidations  and 
industrial  trusts.  A  corporation  which  has  only  one 
plant,  even  though  it  be  of  considerable  importance  in 
its  own  commimity,  for  our  purpose  may  be  put  into  the 
class  of  small  or  local  corporations. 

Two  types  of  business  corporations  that  are  both 
prominent  and  important  in  present-day  mdustry  are  the 
parent  company  and  the  holding  company.    These  two 


TYPES  OF  BUSINESS  CORPORATION  95 

types  are  frequently,  even  usually,  confused,  although 
tiie  distinction  between  them  should  be  kept  in  view. 

53.  The  parent  company.^A  parent  company  is  one 
that  for  some  reason  does  not  desire  to  carry  on  opera- 
tions in  its  own  name  over  the  whqje  country,  and  which 
therefore  organizes  and  holds  all  or  nearly  all  the  stock 
of  one  or  more  subordinate  companies.    There  may  be 
several  reasons  for  so  doing.    The  parent  company  may 
wish  to  operate  in  other  countries  than  the  United 
States,  in  which  case  it  will  obviously  be  necessary  to 
form  a  separate  corporation  in  each  country.    Several 
English  companies,  for  instance,  have  subordinate  com- 
panies in  this  country  and  a  great  many  American 
companies  have  British  subordinate  corporations.    An- 
other reason  for  this  method  of  organization  is  to  avoid 
excessive  local  taxation.    As  the  capitalization  of  each 
of  the  subordinate  corporations  may  be  low,  and  as  the 
parent  company  is  not  officially  known  to  the  authorities 
of  the  states  in  which  the  sub-companies  are  located,  the 
taxes  paid  to  these  states  are  by  this  means  much  re- 
duced.   Another  frequent  reason  is  that  it  is  desirable 
to  have  local  men  in  charge  of  various  plants  of  the 
corporation  and  to  give  these  men  a  stock  interest,  not 
in  the  corporation  as  a  whole,  but  in  the  branch  under 
their  control.    This  is  best  accomplished  by  the  organiza- 
tion of  a  subordinate  company  at  each  branch.    Obvi- 
ously a  parent  company  is  also  a  holding  company  in 
the  sense  that  it  owns  the  stock  of  other  corporations; 
but  these  subordinate  companies  have  been  created  by 
its  officers  in  its  interest,  and  are  in  reality  simply  forms 
in  which  sections  of  its  business  are  organized. 

54.  Nature  of  a  holding  company.— A  holding  com- 
pany proper,  on  the  other  hand,  using  the  term  in  a 
financial,  not  a  legal,  sense,  comes  into  existence  for  the 


96 


CORPORATION  FINANCE 


i 


'  f  f 

:  i, 


M 


if 


>■■■: 


purpose  of  buying  control  of  pre-existing  companies. 
Its  ostensible  object  is  the  buying  of  securities  of  other 
corporations  to  be  held  for  whatever  revenues  they  will 
produce.  The  real  object  of  its  existence,  however,  is 
not  accomplished  unless  it  holds  control  of  all  its  sub- 
sidiary companies  and  directs  their  operations.  Some- 
times this  control  consists  in  holding  a  bare  majority  of 
the  voting  stock  of  the  subsidiary;  but  it  is  generally 
advisable  to  secure  as  much  stock  as  possible,  for  the 
greater  the  extent  of  the  control,  tlie  more  readily  may 
the  holding  company  carry  out  its  plans  to  achieve 
economies  and  fix  prices.  As  we  shall  see  in  our  later 
discussions  of  industrial  combinations,  the  process  of 
economizing  frequently  involves  loss  to  one  or  more  of 
the  subsidiary  companies;  that  is  to  say,  production  is 
often  concentrated  in  the  best  plants  and  the  poor  plants 
are  allowed  to  fall  into  decay.  If  there  is  a  considerable 
minority  interest  in  any  of  these  poorly  equipped  sub- 
sidiary companies,  there  will  inevitably  be  s'  g  objec- 
tions and  legal  obstacles  to  the  plans  of  .  i  holding 
company.  It  is  also  to  the  holding  company's  interest 
to  own  as  much  as  it  can  get  of  the  stock  of  those  sub- 
sidiary companies  the  business  and  profits  of  which  it 
intends  to  expand. 

Thus  a  holding  company  almost  always  aims  to  be- 
come practically  the  sole  stockholder  in  its  subsidiary 
companies,  so  that  it  may  operate  their  properties  un- 
hindered. Although  in  theory  it  merely  holds  securities, 
in  practice  it  is  the  virtual  owner  of  the  railroads,  the 
mines,  the  plants  and  the  other  property  of  its  subsid- 
iaries. We  see  an  expression  of  this  dual  relation,  the 
nominal  and  the  virtual,  in  the  reports  of  almost  all  hold- 
ing companies.  In  these  reports  we  almost  always  find 
two  balance  sheets  and  two  income  statements.     The 


TYPES  OF  BUSINESS  CORPORATION 


97 


first  balance  sheet  shows  as  assets  of  the  holding  com- 
pany simply  the  securities  in  its  treasury  and  the  first 
income  statement  reports  merely  the  dividends  and  in- 
terest received  on  those  securities;  the  second  balance 
sheet— usually  called  "consolidated"  or  "general"— 
shows  as  assets  the  physical  property  of  the  subsidiary 
companies  and  the  second  income  statement  shows  their 
combined  profits.  A  lack  of  knowledge  of  these  simple 
facts  has  frequently  caused  confusion  in  the  minds  even 
of  stockholders  of  holding  companies,  many  of  whom  do 
not  understand  the  status  of  their  own  company. 

55.  l^he  holding  company  as  a  means  of  organizing 
"trusts"— The  holding  company  is  the  method  now  used 
ill  organizing  those  vast  industrial  and  railroad  consoli- 
dations that  are  called  trusts.    Two  former  methods  of 
forming  such  combinations  were  pools  and  trusts — ^this 
word  being  used  in  this  instance  not  in  its  popular,  but 
in  its  legal  sense.    The  pool  is  a  more  or  less  formal 
agreement  among  manufacturers  of  any  given  com- 
modity to  limit  production  and  to  maintain  prices; 
sometimes  this  agreement  includes  the  organization  of 
a  central  selling  agency  through  which  all  the  manufac- 
turers dispose  of  their  product.    Trusts— in  the  legal 
sense— worked  on  a  different  principle;  the  holders  of 
the  voting  securities  of  competing  companies  turned  over 
at  least  a  majority  interest  in  each  company  to  one  man 
or  a  small  group  of  men  to  hold  in  trust,  and  received  in 
return  what  were  known  as  trust  certificates.    In  other 
words,  a  single  voting  trust  for  a  number  of  competing 
companies  was  formed.    The  trustees  had  power  to  vote 
all  the  stock  in  their  possession  and  thus  exercise  control 
over  the  policies  of  competing  companies.    Pools  proved 
to  be  unworkable  and  trusts  illegal,  for  reasons  which  it 
belongs  to  the  science  of  economics  rather  than  to  corpo- 

C— VI— 7 


98 


CORPORATION  FINANCE 


l 


!  1 


I 


I 

fi 

si 

i 


ration  finance  to  discuss,  and  both  have  been  giv3n  up  in 
favor  of  the  modern  form  of  combination,  the  holding 
company. 

The  holding  company  was  first  made  possible  in  1889 
by  an  amendment  to  the  corporation  law  of  the  State  of 
New  Jersey,  which  reads  as  follows : 

Any  corporation  may  purchase,  hold,  sell,  assign,  transfer, 
mortgage,  pledge,  or  otherwise  dispose  of  the  shares  of  the  cap- 
ital stock  of,  or  of  any  bonds,  securities,  or  evidences  of  indebt- 
edness created  by  any  other  corporation  or  corporations  of  this 
or  any  other  state,  and  while  owner  of  said  stock  may  exercise 
all  the  rights,  powers,  and  privileges  of  ownership,  including 
the  right  to  vote  thereon. 

Professor  Edward  Sherwood  Meade,  of  the  Univer- 
sity of  Pennsylvania,  includes  in  his  valuable  work  on 
Trust  Finance  some  remarks  as  to  the  meaning  and 
results  of  this  Act  which  are  of  such  interest  and  impor- 
tance that  they  are  presented  below  in  full : 

For  momentous  consequences,  this  statute  of  New  Jersey  is 
hardly  to  be  equaled  in  the  annals  of  legislation.  Sixteen 
sovereign  states  had  passed  searching  and  stringent  laws  in 
prohibition  of  any  attempt  to  restrict  competition ;  laws  whose 
detailed  minuteness  of  specification  could  hardly  be  improved 
upon ;  which  had  been  proved  effective  against  the  only  perma- 
nent form  of  competition  regulation  yet  attempted,  and  which 
undoubtedly  represented  the  conviction  of  a  majority  of  the 
people  of  the  United  States — a  conviction  finding  more  general 
and  authoritative  expression  in  the  Sherman  Anti-trust  Law, 
and  strengthened  by  the  anti-monopoly  provisions  of  the  com- 
mon law ;  a  well-nigh  unanimous  sentiment  opposed  to  any  form 
of  trust  or  pool ;  and  the  little  State  of  New  Jersey,  containing 
two  per  cent  of  the  population  and  one  and  three-tenths  per 
cent  of  the  wealth  of  the  United  States,  by  the  simple  act  of 
amending  its  corporation  law,  nullified  the  anti-trust  laws  of 
every  state  which  had  passed  t  em. 


TYPES  OF  BUSINESS  CORPORATION 


po 


A  trust  could  not  exist  in  New  York.    The  courts  of  New 
York  would  not  allow  the  creation  of  a  holding  company  to 
perpetuate  the  trust  under  another  and  slightly  different  form. 
Here  are,  say  ten  corporations,  all  located  in  New  York,  which 
were  formerly  engaged  in  competition,  later  organized  into  a 
trust,  and  more  recently  dissolved  by  the  New  York  courts. 
Tlie  owners  of  these  corporations,  having  experienced  the  bene- 
fits of  combination,  wish  to  continue  their  organization  under 
another  form.     They  apply  to  the  New  York  Legislature  for 
permission  to  charter  a  new  company  which  shall  purchase  all 
their  stock,  and  whose  officers  can  thus  control  their  united 
policy.    The  Legislature  refuses  the  application  on  the  ground 
that  the  new  corporation  would  be  the  old  trust  under  a  new 
name,  and  wonld  therefore  be  existing  in  violation  of  the  same 
law  which  had  been  recently  employed  against  its  predecessor. 
The  case  of  the  stockholders  seems  hopeless.    They  are  citizens 
of  New  York.    Their  corporations  are  chartered  by  New  York. 
New  York  absolutely  forbids  them  to  combine  in  restraint  of 
trade.    What  are  they  to  do? 

In  despair  they  turn  their  eyes  southward.    There,  upon  the 
other  side  of  the  North  River  stands  the  State  of  New  Jersey, 
beckoning  them  with  welcoming  hands.     For  a  franchise  bonus 
or  fee,  New  Jersey  will  come  to  their  assistance.    New  Jersey 
will  authorize  them  to  form  a  corporation  which  is  empowered 
to  buy  the  stocks  of  their  ten  companies.    New  Jersey  will  allow 
them,  as  a  New  Jersey  corporation,  to  perfect  the  combination 
in  New  York — for  operation  in  New  York — which  the  laws  of 
New  York  absolutely  forbid.    New  Jersey  will  thus  deprive  the 
State  of  New  York  of  the  right  to  control,  in  the  interests  of 
what  her  Legislature  considers  to  be  public  policy,  the  corpora- 
tions which  New  York  has  created  and  over  which  it  assumes 
sovereign  power.    New  Jersey  will  perform  a  similar  office  for 
any  body  of  individuals  who  may  wish  to  evade  the  anti-trust 
laws  of  any  State  in  the  Union.    As  a  New  Jersey  corporation, 
they  may  combine  and  coalesce  for  the  operation  of  any  num- 
ber of  competing  plants,  anywhere  in  the  United  States,  with 
none  to  molest  or  make  them  afraid. 


100 


CORPORATION  FINANCE 


|- 


This  quotation  is  not  intended  to  give  the  impression 
that  holding  companies  are  necessarily  formed  in  every 
instance  for  unlawful  or  harmful  purposes.  On  the 
contrary,  the  writer  wishes  to  record  here  his  conviction 
that  some  form  of  industrial  and  railroad  combination 
under  present  conditions  in  this  country  is  both  inevita- 
ble and  desirable.  It  is  inev  itable  because  by  means  of 
combination  production  as  a  rule  can  be  carried  on 
more  cheaply  than  would  otherwise  be  possible;  it  is 
desirable  because  through  the  working  of  economic 
forces  the  advantages  gained  by  this  cheapness  of 
production  will  be  distributed  in  the  long  run  among 
all  classes.  To  defend  and  illustrate  this  proposition 
would  lead  us  too  far  away  from  our  main  subject.  The 
statement  is  worth  bearing  in  mind,  however,  especially 
by  those  persons  who  are  prone  to  join  in  thoughtless 
outcry  against  the  "trusts." 

56.  Complexity  of  holding  companies. — Holding 
companies  may  be  formed,  not  only  to  acquire  stock  of 
operating  companies,  but  also  to  obtain  control  of  other 
holding  companies;  then  there  is  no  reason,  of  course, 
why  the  stock  of  the  second  holding  company  should  not 
be  purchased  sooner  or  later  by  a  third  still  greater  hold- 
ing company.  Thus  there  may  be  built  up  a  most 
intricate  and  extensive  oi  ganization,  in  which  so  many 
companies  may  be  involved  that  it  becomes  a  difficult 
matter  to  trace  their  relations  to  each  other.  Many  ex- 
amples, each  of  which  would  require  considerable  expla- 
nation, might  be  given.  The  reader  will  get  a  sufficiently 
clear  idea,  however,  as  to  how  complex  organizations  of 
this  kind  are  built  up  if  he  will  study  the  accompany- 
ing chart  of  the  Intcrborough-Metropolitan  Company, 
which  was  prepared  for  the  Public  Service  Commission 
of  the  First  District  of  the  State  of  New  York.    The 


TYPES  OF  BUSINESS  CORPORATION  101 

Interborough-lSIetropolitan  Company  controls  all  the 
street  car,  elevated  and  subway  railway  lines  in  the  prin- 
cipul  boroughs  of  New  York  City.  It  was  formed,  as 
shown  in  the  chart,  by  an  exchange  of  its  securities  for 
the  securities  of  two  formerly  competing  companies,  the 
Metropolitan  Securities  Company  and  the  Interborough 
Kapid  Transit  Company.  The  relations  of  these  two 
companies  to  each  other,  to  their  direct  subsidiaries,  and 
to  the  subsidiaries  of  their  subsidiaries,  are  as  clearly 
as  possible  presented  in  the  chart. 

57.  Organization  of  the  Standard  Oil  Company. —To 
illustrate  further  the  extent,  as  well  as  the  complexity, 
of  the  organization  of  a  great  holding  company,  there  is 
presented  below  the  most  complete  list  ever  published  of 
the  subsidiaries  formerly  controlled  by  the  Standard 
Oil  Company.  The  reader  will  find  this  list  of  value, 
not  only  for  the  present  purpose,  but  for  future  refer- 
ence The  Standard  Oil  Company  of  New  Jersey  was 
tlie  "parent"  of  something  over  half  of  the  subsidiaries 
shown  in  this  list;  it  was  a  true  holding  company,  in  the 
sense  in  which  that  term  has  been  defined  in  this  chapter. 
so  far  as  the  other  subsidiaries  named  were  concerned. 

I  COMPANIES  WHOSE  STOCK  WAS  OWNED  niHECTLY  BY  THE 
STANDARD  OIL  COMPANY 

Total      Per  Ceni 

Capitnl    Owned  bji 

Stock.    Standard. 

AnKlo-Amerionn  Oil  Co.,  Ltd ^^  ^^ 

Atlantic  Reflnmg  Co. ^^3 

Hr-lford  Petroleum  Co ^^^^  ^^ 

l,,.rne-Scry.nserO.^^ ••••••••  ^^ 

n,K-keye  Pipe  Line  Co ^^,^^^^  ^^ 

(.rterOilCo     ...^. ^^^  ^^^ 

(luseLrough  Mfg.  Co ^^^^^  ^^ 

i  ..ntinrntnl  Oa  Co •■■ ^^^^^^^^  ^^ 

I  wscent  Pipe  Line  Co 


102 


CORPORATION'  FINANCE 


Total      Per  Cent 
Capital    Owned  by 

Name.  Stock.    Standard. 

Clarksburg  Light  &  Heat  Co $100,000  51 

Deutsch-Amcrikanische   Petroleum   Gesellschaft 2,i250,000  100 

Deutsch-Anierikanlst'he  Petroleum  Gesellschaft  (share 

warrants 5,350,000  99.9 

Empire  Refining  Co 100,000  78.5 

Enipreza  Industrial  de  Petroiio 500,000  70 

Eureka  Pipe  Line  Co 5,'    D,000  100 

Forest  Oil  Co ?  ? 

Gilbert  &  Barker  Mfg.  Co 40,000  100 

Galena-Signal  Oil  Co.,  pfd 3,000,000  74.4 

Galena-Signal  Oil  Co.,  com 8,000,000  70 

Hazelwood  Oil  Co ?  ? 

Hope  Natural  Gas  Co 500,000  100 

Indiana  Pipe  Line  Co 1,000,000  100 

Interstate  Cooperage  Co 300,000  100 

Lawrence  Natural  Gas  Co 450,000  100 

Mahoning  Gas  Fuel  Co 150,000  99.9 

Marion  Oil  Co 100,000  50 

Mountain  State  Gas  Co 500,000  100 

National  Transit  Co 35,455,300  99.9 

New  York  Transit  Co 5,000,000  100 

Northern  Pipe  Line  Co 4,000,000  100 

Northwestern  Ohio  Natural  Gas  Co 3,775,350  59.4 

Ohio   Oil  Co 10,000,000  99.9 

People's  Natural  Gas  Co 1,000,000  100 

Pennsylvania  Lubricating  Co 50,000  60 

Pittsburg  Natural  Gas  Co 310,000  100 

Komano-Americana 2,500,000  100 

Reserve  Gas    Jo 3,335,000  60 

RafRniTie   Franvi;  o   80,000  100 

River  Gas  Co 190,000  53.e 

Solar  Refining  Co 500,000  99.8 

Southern  Pipe  Line  Co 10,000,000  100 

South  Peiin  Oil  Co 3,500,000  100 

South   W^st   Pennsylvania   Pipe  Lines .1,^00,000  100 

Standard  Oil  C«...  California   17.000,000  99.9 

Standard  Oil  Co.,  Indiana 1,000,000  99.9 

Standard  Oil  Co.,  Iowa 1.000,000  100 

Standard  Oil  Co.,  Kansas 1.000,000  99.9 

Standard  Oil  Co.,  Kentucky   1,000,000  99.9 

Standard  Oil  Co.,  Nebraska 600,000  99.9 

Standard  Oil  Co..  New  York 15,000,000  100 

Standard  Oil  Co.,  Ohio 3,500,000  99.9 

Swan  &  Finch  Co 100,000  100 


TYPES  OF  BUSINESS  CORPORATION  103 

Total  Percent 
Capital  Owned  by 
Stock.    Standard, 

yame.                                                                                       ^     25  000  gg.g 

imlerhay  Oil  Co 3,500,000  99.9 

inion  Tank  Line  Co 2,500,000  100 

Vmiuim  Oil  Co. ^jjQ,jOO  68.6 

UMt.rs-Pierce  Oil  Co.   .  .^ ^  ^0 

West  India  Oil  Refining  Co ^^^^  ^^ 

West  Virginia  Oil  Co ^^^^  ^^^ 

West  India  Oil  Co j^^^  7j  ^ 

Washington  Oil  Co 

II     COMPANIES  WHOSE  STOCK  WAS  OWNED  PRIMARILY  BY 
SUBSIDIARY  COMPANIES. 

A merikanische  Petroleum  Anlagen '^10^  100 

Automaat   Co ,^^00  35 

1  .schweiler  Petroleum  Import oooioOO  60 

(liient  Petroleum  Co 'i^'oOO  100 

I  lollandsche  Petroleum  Vereemging  . ... . . . . .  •  •  •  •  •  •  •  ' 

Mannheim  Bremer  Petroleum  Actien  Gesellschaft . . . .          T50^  100  ^ 

IVtrolifere  Ghent ^^^',^00  iqo 

1  Vtrollf ere  Nationale    ■■■■—- 3„,000  54.6 

IVtroleum  Raff,  vorm  August  Korff...                                    ^^^'  ^^ 

Societe  AnonymeH.  ReithCo...                                                     250  100 

lUieinische  Petrol.  Actien  Gesellschal ;                 ^ 

A.tien  Ge.scllschaft  Atlantic   -^  ^^ 3 

American  Petroleum  Co ^^ 

Street  Tank  Wagon  Business-Duren ^♦'^  ^^ 

Gibraltar  Petroleum  Co •••-••               '  ^^ 

Imperial  Oil  Co.,  Ltd jJnnn  HI  3 

net  Danske  Petroleums  Aktieselskab ^^^  *  -^ 

....         1        r»ii    r-^                                         20,000,000  »»•» 

Tidewater   Oil   Co :        '                                 Qmnon  100 

1  ank  Storage  and  Carriage  Co.,  Ltd.,  pfd 300.000  100 

Tank  Storage  and  Carriage  Co.,  Ltd.,  orclinary «.^  1^ 

S..deta  Italio- Americana  per  Petrolio 1.000,000  W 

Aktieselskabct  Ostlandskc  Petrol.  Cie 16-."00  ».» 

Krooks  Petrol,  og  Olje  Aktiebolag 270.000  10 

Skanska  Petroleums  Aktiebolaget "*•»»»  «" 

Svenska  Petroleums  Aktiebolaget ^^'"^  'J 

Svdsvenska  Petroleums  Aktiebolaget 9»,M0  *♦.• 

Wcstkustens  Petroleums  Aktiebolag "7.W0  i».a 

Kocnlgsberger  Hnndeln  Compngnle «"•«»  "•" 

l'.trolcum  Import  Compngnie  • ""'"^ 

S.  h wel«er5schc  Petroleum  HandeU  Gesellschaft 60,000  60 

T>  i-„i.a                                     80,000  oo.a 

Societe    Anonyme    Petrolea ' 

Wachs.  &  Flossner  Petrol.  Ge9ell»ch.ft 2i.«»  100 


104 


CORPORATION  FINANCE 


f,: 


■J 


i  I  • 


>.; 


■  i 


1    ! 


Capital 

^ame.  Slock. 

Westphalische  Petroleum  Gesellschaft  $     i?o,000 

S.  T.  Baker  Oil  Co 50,000 

Galena  Oil  Co.— Soci^t^  Anonyme  Fran^aise 40,000 

Queen  City  Oil  Co.,  Ltd 200,000 

Connecting  Gas  Co 8:35,000 

Cumberland   Pipe  Line  Co 1,000,000 

East  Ohio  Gas  Co «',00o',000 

Franklin  Pij)e  Line  Co 50,000 

New  Domain  Oil  and  Gas  Co 1,000,000 

Prairie  Oil   and   Gas  Co loioOO^OOO 

St.  Paul  Petroleum  Tank-  (Lim.) 250,000 

Societa  Meridionale  per  Commercio  del  Petrolio 120,000 

Societa  per  pli  Olii  Mineral! 156,000 

Soeiet^  Tunsiemie  des  Petroles 80,000 

International   Oil  Co.,  Ltd 2,750,000 

Vacuum  Oil  Co.,  Pro|)rletary  Limited .500,000 

Vacuum  Oil  Co.,  Rcszvenytarsasag 2,100,000 

Vacuum  Oil  Co.,  Limited 275,000 

^'acuum  Oil  Co.— .Socictc  .\nonyrnc  Franvaise 400,000 

Deutsch— Vacuum  Oil  Co ((25,000 

Vacuum  Oil  Co.— Societa   .Anonyme    Italiana 100.000 

Vacuum  Oil  Co.— .Xktiebolag 27,000 

Taylorstown  Natural  Gas  Co 10,000 

Totnl $229,963,195 

Standard  Oil  Co.  of  New  .Icrsey 98,.S:W300 

Grand  Total $328,301,495 


Per  Cent 
Owned  bii 
Standard. 
100 
100 
100 
87.4 
49.9 
99.9 
100 
39 
99.!) 
100 
55 

52.1 
65 
99.4 
100 
100 
99.9 
100 
100 
100 
96.(i 
70 


ii 


CHAPTER  VII 


SOURCES  OF  CORPORATE  FUNDS 

.)8.  Summary  of  preceding  chapters.— The  first  six 
chapters  of  this  book  cover  those  fundamental  features 
„f  corporation  law  which  are  essential  to  an  understand- 
in.,  of  the  financial  organization  and  management  of 
corporations.    We  have  taken  up  in  turn  among  other 
topics:  the  advantages  of  corporations  over  other  forms 
of  conducting  business;  the  legal  powers  of  the  corpora- 
tion; the  charter;  the  by-laws;  the  duties,  rights  and 
privileges  of  stockh  Iders;  of  directors;  of  officers;  the 
process  of  incorporation ;  tlie  factors  to  consider  in  select- 
in.'  the  state  of  incorporation;  the  relative  advantages 
aiul  disadvantages  of  several  states;  the  characteristics 
of  common  and  preferred  stock;  the  use  of  cumulative 
voting  and  of  voting  trusts;  the  nature  of  a  close  corpo- 
ration; of  an  ordinary  operating  company;  of  a  parent 
con.panv;  of  a  holding  company.     All  of  this  matter, 
altliougii  essential,  is  intended  merely  as  an  introduction 
to  what  follows.    Our  real  subject  is  not  the  legal,  but 
the  financial,  side  of  corporation  practice,  and  this  sub- 
i(  ct  we  are  now  ready  to  take  up.    It  must  not  be  for- 
.„tten  at  anv  stage  of  thi ,  study,  however,  that  all  finan- 
,  ial  measures  must  comply  with  and  be  in  harmony  with 
the  legal  principles  that  have  been  discussed. 

:)0.  Four  HonrccH  of  corporate  fiintJs.—ln  financing  a 
(orporation  the  managers  may  go  for  funds  to  six  dif- 
1 1  rent  sources,  as  follows: 

105 


106 


CORPORATION  FINANCE 


a 


■   i.     4 

H  ' 


:  *i  ■ 


\  • 


*!' 


1^- 
■  > 


p 


(a)  Active  interests  in  the  business 

(b)  Profits  of  the  business 
(e)      Trade  creditors 

(d)  Banks 

(e)  The  investing?  public 

( f )  The  speculative  public. 

There  is  no  need  of  discussing  in  detail  methods  of 
raising  funds  from  peoj)le  who  are  actively  engaged  in 
the  management  of  the  corporation.  Each  one  presum- 
ably will  be  fully  informed  as  to  the  records  and  pros- 
pects of  the  company  and  will  regulate  his  investments 
accordingly.  In  the  case  of  close  corporations  the  proc- 
ess of  raising  funds  is  simply  to  allow  each  person 
interested  to  invest  as  nuich  as  he  can  and  will  on  terms 
that  are  settled  by  direct  bargaining. 

Profits  that  are  not  paid  out  from  a  surplus  may 
be  one  of  the  most  important  soiu-ces  of  funds.  The 
Carnegie  Steel  Company,  as  we  shall  see  later,  is  a  con- 
spicuous example.  This  particular  topic  is  fully  dis- 
cussed in  later  chapters  and  need  only  be  mentioned 
here. 

It  may  not  be  plain  at  first  sight  that  the  trade  cred- 
itors of  a  concern  are  in  reality  fimiishing  part  of  the 
funds  necessary  to  the  business;  but  a  moment's  reflec- 
tion makes  it  evident  that  a  company  which  continually 
carries,  say,  $10,000  of  accounts  payable,  thereby  makes 
that  amount  available  for  its  business.  If  the  trade  cred- 
itors should  demand  cash  for  every  purchase,  the  concern 
would  have  to  raise  the  $10,000  from  some  other  source. 
In  some  lines  of  business,  especially  retail,  a  very  small 
investment  is  sufficient  to  carry  on  comparatively  large 
operations  simply  because  long-time  payments  are  per- 
missible. Usually,  however,  the  merchant  or  manufac- 
turer who  buys  on  credit  also  sells  on  credit,  in  which 


SOURCES  OF  CORPORATE  FUNDS 


107 


case  the  funds  derived  from  trade  creditors  are  promptly 
placed  at  the  disposal  of  trade  debtors. 

Of  course,  it  is  possible  also  that  a  business  may  draw 
its  funds  from  the  advance  payments  of  the  people  who 
buy  its  products;  but  this  is  so  unusual  a  case  that  it  is 
hardly  worth  mentioning. 

Banks  are  institutions  whose  primary  function  is  to 
furnish   funds   for  commercial  enterprises.     Without 
going  into  the  theory  of  banking,  it  may  be  pointed  out 
that  banks  are  dealers  in  credit.    They  buy  the  credit 
of  other  people  in  the  form  of  notes  and  similar  obliga- 
tions and  they  sell  their  own  credit  principally  in  the 
form  of  deposits.    Any  reader  to  whom  this  statement 
is  not  altogether  clear  may  turn  to  the  volume  on  Money 
AND  Banking  for  further  enlightenment.    In  order  to 
make  its  credit  good  a  bank  must  always  be  ready  to  re- 
deem promptly  every  check  that  may  be  presented  to  it 
for  payment.     Therefore,  a  well-managed  bank  will 
never  tie  up  its  assets  in  permanent  investments,  but  will 
keep  them  always  "liquid."    For  that  reason  the  corpo- 
ration manager  can  look  to  banks  only  for  short-time 
h)ans,  usually  not  longer  than  ninety  days.     We  will 
discuss  the  requirements  of  banks  in  detail  in  the  next 
chapter.    It  is  enough  for  the  present  to  say  that  funds 
secured  from  banks  will  almost  always  be  short-time 
h>ans  in  strictly  limited  amoimts  backed  by  unquestion- 
able security. 

GO.  The  investing  public  as  a  source  of  funds. — The 
fifth  source  of  funds  is  the  investing  public.  This 
phrase  covers,  not  only  individuals,  but  institutions.  The 
most  important  classes  of  investors  are:  (a)  professional 
and  salaried  people  who  have  no  business  of  their  own 
in  which  to  place  their  savings;  (b)  women  and  minors 
wlio  have  inherited  money;  (c)  estates  held  in  trust; 


108 


CORPORATION  FINANCE 


(d)  savings  institutions;  (e)  insurance  companies, 
liusiness  men  are  not  investors  in  securities  of  other  cor-, 
porations  than  those  in  which  they  are  directly  interested 
to  any  great  extent,  for  the  obvious  reason  that  they  are 
apt  either  to  put  their  savings  into  their  own  concerns 
or  to  seek  larger  returns  than  are  offered  by  strictly 
mvestment  securities. 

One  of  the  great  problems  of  raising  funds  for  many 
kinds  of  business  is  to  arouse  interest  and  inspire  confi- 
dence in  the  investing  public.  They  may  be  appealed 
to  by  advertisements  and  circular  letters — a  plan  which 
is  seldom  successful;  or  they  may  be  reached — usually 
with  much  better  results — through  bond  and  brokerage 
houses  whose  business  it  is  to  retail  investment  securities 
to  their  clients.  This  is  another  topic  that  will  come  up 
for  later  discussion. 

61.  Difference  between  investment  and  speculation. — 
This  is  a  good  place  to  define  the  words  "investment" 
and  "speculation."  The  former  word,  as  it  is  used  in  a 
somewhat  technical  sense  by  the  leading  financial  pa- 
pers, refers  to  a  security  or  other  property  which  is 
practically  certain,  so  far  as  human  minds  can  foresee, 
not  to  depreciate  in  value.  No  security  in  which  the 
element  of  risk  is  prominent  can  properly  be  called  an 
investment.  If  the  probabilities  are  strong,  but  not  con- 
clusive, that  the  security  or  property  will  not  depreciate 
in  value,  then  the  terms  semi-investment  or  semi-specu- 
lative may  be  applied.  To  illustrate,  a  United  States 
Government  bond  is  certainly  an  investment,  and  so  is 
a  first  mortgage  bond  (in  any  of  the  standard  railroads. 
Most  of  the  industrial  bonds,  however,  even  where  the 
earnings  are  large  and  the  prospects  apparently  good, 
would  be  classed  as  semi-investments,  because  there  is 
always  danger  that  competition  or  some  new  invention 


SOURCES  OF  CORPORATE  FUNDS 


109 


will  cut  into  the  business.  In  the  same  way  high-grade 
preferred  stocks  of  successful  railroads  and  industrial 
companies  would  be  called  either  semi-investment  or 
semi-speculative  issues.  For  our  purposes  in  this  book 
these  finer  distinctions  are  not  necessary  and  would  per- 
haps be  confusing.  We  shall,  therefore,  use  the  word 
"investment"  in  a  more  popular  sense  to  include  the  true 
investment  and  the  semi-investment  or  semi-speculative 
securities.  We  may  define  it,  in  its  objective  sense, 
as  any  security  or  other  property  the  principal  of  which 
seems  safe  and  returns  on  which  (interest,  dividends  or 
rent)  seem  certain. 

The  great  majority  of  corporate  stocks  would  be 
classed  as  speculative;  for  no  matter  how  promising  they 
may  be,  conservative  brokers  would  not  in  most  cases  be 
willing  i^  call  them  safe.  Calling  a  security  "specula- 
tive," the  reader  should  understand,  is  not  necessarily 
condemning  it  or  objecting  to  its  sale.  As  a  matter  of 
fact,  few  corporations  comparatively  have  anything  but 
speculative  securities  to  offer.  Moreover,  it  is  only  by 
more  or  less  speculative  purchases  that  returns  on  capital 
above  5,  6  or  7  per  cent  may  be  obtained.  Nearly 
all  investment  securities  have  been  at  one  time  specula- 
tive in  character.  When  the  terms  "highly  speculative" 
or  "purely  speculative"  are  used,  however,  it  is  generally 
saf'j  to  assume  that  the  writer  intends  to  convey  the 
idea  that  the  security  in  question  has  a  very  remote 
chance  of  ever  getting  into  the  investment  class. 

62.  The  speculative  public  as  a  source  of  funds. — The 
speculative  public  may  be  roughly  subdivided  into  three 
groups:  (a)  ill-informed  people  who  do  not  know  the 
(liflPerence  between  an  investment  and  a  speculation  and 
who  are  continually  placing  their  hard-earned  money  in 
the  hands  of  unscrupulous  promoters  in  the  blind  faith 


110 


CORPORATION  FINANCE 


1 
MA  - 


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III  I 

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V: 


II 


s 


that  they  are  making  an  investment;  (b)  intelligent 
business  and  professional  men  who  buy  and  hold  for  a 
rise  speculative  securities  and  property  in  the  full  knowl- 
edge that  they  are  taking  chances;  (c)  speculators  who 
buy  securities  and  property  "on  margin"  in  the  hope  of 
making  a  quick  and  large  profit.  Group  (a)  may  be 
reached  by  means  of  circular  letters  and  advertising; 
group  (b),  generally  by  personal  solicitation  or  through 
the  stock-market;  group  (c),  usually  through  the  stock- 
market.  A  detailed  discussion  of  the  methods  of  reach- 
ing and  interesting  possible  buyers  of  corporate  securi- 
ties must  be  deferred.  For  the  present  our  attention 
should  be  confined  to  the  securities  themselves. 

Corporate  funds  fall  into  two  classes :  borrowed  funds 
and  owned  funds.  The  borrowed  funds  are  secured 
through  accounts  and  bills  payable,  through  b^jpik  leans 
or  through  bonds  and  mortgages.  The  owned  funds  are 
secured  through  issues  of  stock. 

63.  Desirahility  of  borroiving  funds. — ^Why  should  a 
corporation  borrow  funds  at  all  ?  The  reader  will  per- 
haps answer,  as  many  people  do,  that  it  borrows  from 
necessity;  that  as  soon  as  possible  it  ought  to  pay  off  its 
debts,  just  as  a  man  gets  rid  of  the  mortgage  on  his 
house  as  soon  as  he  can.  The  fact  is,  however,  that  for 
a  corporation  to  be  out  of  debt  is  no  credit  to  it,  but 
rather  a  sign  that  it  is  either  in  a  dangerous  position  or 
not  intelligently  managed.  No  method  of  raising  funds 
is  cheaper  than  borrowing,  unless  we  include  stealing. 
Therefore,  a  corporation  should  borrow  as  much  as  it 
can  within  the  limits  of  safetv. 

To  illustrate  the  desirability  of  borrowing  part  of  the 
funds  of  a  corporation :  Suppose  a  manufacturing  com- 
pany needs  $100,000  to  carry  on  its  business  and  pro- 
duces an  average  net  income  of  $6,000.    If  it  raises  the 


SOURCES  OF  CORPORATE  FUNDS 


111 


whole  $100,000  by  stock  issues,  it  will  only  pay  6  per 
cent  dividends — not  enough  to  compensate  for  the  risks 
and  uncertainties  of  the  business.  Now  suppose  that 
the  company  is  dissolved  and  the  same  business  is  carried 
on  under  a  new  company  which  sells  $50,000  of  5  per 
cent  bonds,  gets  additional  and  larger  credits  to  the 
extent  of  $10,000  and  borrows  $5,000  from  bunks  at  an 
average  rate  of  5  per  cent.  Then,  only  $35,000  stock 
need  be  issued,  the  income  of  which,  after  deducting 
interest  charges  o^  $2,750,  will  be  $3,250,  or  9.3  per  cent, 
a  satisfactory  return. 

Thomas  L.  Greene,  author  of  "Corporation  Finance,'* 
points  out  that  a  few  years  ago  three-quarters  of  owned 
to  one-quarter  of  borrowed  funds  was  thought  about 
right,  whereas  now  the  proportion  in  well-managed  cor- 
porations is  nearer  one-quarter  owned  to  three-quarters 
borrowed.  The  result  has  been  to  reduce  the  average 
rate  of  returns  on  capital  and  thereby  to  reduce  cost  of 
production  and  prices.  In  order  to  make  profits  at  all 
under  present  conditions  mercantile  and  manufacturing 
concerns  must  borrow  heavily.  Of  course,  there  are 
limits  to  the  safety  and  advantages  of  borrowing. 

On  the  following  pages  are  given  five  recent  balance 
sheets  (Herring-Hall-Marvin  Safe  Company,  Ameri- 
can Thread  Company,  Bethlehem  Steel  Corporation,  A. 
Booth  &  Company,  and  Central  Leather  Company) 
selected  practically  at  random,  which  will  perhaps  make 
these  statements  somewhat  more  vivid  and  concrete. 
Assuming  that  the  balance  sheet  of  the  first-named 
concern  is  based  on  the  actual  value  of  the  property 
(which  is,  to  be  sure,  a  pure  assumption)  we  arrive  at 
the  real  amount  of  funds  utilized  in  the  business  by 
deducting  from  the  total  assets  the  item  of  "Pat- 
ents, good-will,  etc.,  $290,000,"  leaving  approximately 


h 


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II 

'i  ' 
I   \ 

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if- 


112  CORPORATION  FINANCE 

HERRING-HALL-MARVIN  SAFE  CO. 

Assets: 

Real  estate,  plant,  equip.,  &c $531,148 

Pateuts,  good-will,  &c 290,000 

Inventory 433,118 

Cash,  notes  &  accts.  rec 219,617 

Advances,  prepayments,  &c 14,834 

Notes  rec.  discounteti 4,670 

ToUl $1,493,387 

Liabilities: 

Preferred  stock $400,000 

Common  stock 700.000 

Debenture  notes 100,000 

Accts.  pay.  &  accrd.  accts 60,950 

Notes  payable 155,949 

Notes  rec.  discounted 4,670 

Reserves 34,422 

Surplus 37,396 

ToUl ; $1,493,387 


t  i 


I 


mi 
P 

ill 


AMERICAN  THREAD  CO. 

Assets : 

Land,  water,  &  steam  power,  mills,  machinery,  plant 

&  eflfects $12,694,898 

Stooks-in-trade  at  net  cost 4,960,971 

Accounts  receival)le,  net 1,016,445 

Cash  at  bankers  &  in  hand 341,483 

Sundry  investments 2:?9,840 

Advance  payments 39^.93 

Total    $19,281,927 

9 

Liabilities:  . 

Com.  stock  ($...50  paid  up) .«V1,200,000 

6%  Pfd.  stock  (fully  paid) 4,890,475 

4%  1st  mtge.  bonds 6,000,000 

English  Sew.  Cot.  Co.  Ltd 351,164 

Accounts  payable 770,410 

Bond    int.  accrued ^0,000 


CORPORATE  FUNDS  AND  CAPITALIZATION  113 

Depreciation  fund 9,076^7 

Div.  on  com.,  payable  July 588,000 

Profit  &  loss 344,891 

Total $19,28M27 

BETHLEHEM  STEEL  CORPORATION 

Assets: 

Property  account $72,891,695 

Raw  materials  &  supplies 4,919,590 

Worked  materials  and  contracts  in  progress,  less  bills 

rendered  on  acct 5,487,144 

Accts.  &  notes  receivable 9,909,956 

Miscellaneous  investments 865,374 

Special  funds  ■mth  trustee 34,464 

Cash 1,963,481 

Deferred  charges  to  operation 447,800 

ToUl $95,589,300 

Liabilities: 

Preferred  stock $14,908,000 

Common  stock 14,864,000 

Bonds  &  notes  outstanding. 83,599,033 

Notes  payable 3,388,509 

Accounts  payable 6,459,314 

Bond  interest  accrued 448,097 

Coupons  payable 435,710 

Depreciation  reserve 9,586,010 

Reserves  for  relining  furnaces,  &c 390,069 

Contingent  reserve 4,413,050 

Appropriated  for  additions  &  working  capital 7,500,000 

Unappropriated  surplus 4,411,517 

Total $96,599,300 

A.  BOOTH  &  CO. 

Assets: 

Cash    »510,777 

Merchandise   937,976 

Accounts  receivable 1,556,689 

Bills    receivable 930,560 

Unexpired  insurance,  R.  R.  mileage,  etc 119,4^'.8 

Treasury  preferred  stock 20,800 

Treasury  comtnott  stock 170,650 

Plants,  steamboats,  real  estate,  etc 5,510,927 

Total    $9,757,827 

C— VI— 8 


t:.<.t!>4 


si  .; 


■i    ' 


lU  CORPORATION  FINANCE 

Liabilities : 

Common  stocit $3,000,000 

Preferred  stocit 2,500,000 

Surplus   1,523,700 

Undivided   profits 203,138 

Accounts  payable 931,989 

Bills  payable 1,601,000 

Totel    ?9,757,827 

CENTR  VL  LEATHER  CO. 

Assets: 

Property  account $63,210,120 

Investments 319,987 

Leather  &  other  finished  products 9,995,527 

Hides  &  leather,  raw  &  iu  process,  &c 32,463,316 

Accounts  receivable 7,220,896 

Bills  receivable 448,747 

Call  loans  &  short  time  investments 5,632,274 

Cash 1,777,227 

Deferred  charges 133,984 

ToUl $121,211,078 

Liabilities: 

Preferred  stock $33,290,050 

Common  stock 30,701,030 

First  mortgage  bonds 85,750,150 

U.  S.  Leather  debentures 12,000 

Real  estate  mortgages 80,000 

Foreign  drafts 1,730,070 

Accounts  payable 1,021,283 

Accrued  interest 459,552 

Ptd.  dividend,  payable  Jan.  2 582,732 

Com.  dividend,  payable  Feb.  2 793,000 

Reserves 1,333,475 

Surplus 6,437,828 

Totd $121,21 1.078 


CORPORATE  FUNDS  AND  CAPITALIZATION     115 

Tlie  borrowings  including  bonds,  bills  payable  and 
accounts  payable,  are  approximately  $317,000,  or  some- 
thing over  27  per  cent  of  funds. 

To  arrive  at  the  actual  funds  utilized  in  the  property 
„f  the  American  Thread  Company  we  should  deduct 
from  the  $19,281,000  assets  the  depreciation  fund  of 
s> 076,000.  Of  the  total  funds,  approximately  $17,- 
•'00,000,  about  $7,750,000  is  borrowed  (including  bonds. 
,kl,ts  to  stock-  and  bond-holders  and  to  English  Sew- 
lujy  Cotton  Co.,  and  accounts  payable).  The  per- 
centage of  borrowing  is  45. 

Deducting  reserves  for  depreciation  we  find  funds  of 
the  Bethlehem  Steel  Company  to  be  approximate  y 
^80,000,000.    Borrowings  are  about  $44,000,000  or  45 

per  cent. 

In  the  case  of  A.  Booth  &  Company  there  are  funds 
of  about  $9,750,000  and  borrowings  of  $2,500,000,  or 
•'-,  6  per  cent.  As  the  firm  failed  in  September,  1908, 
this  low  percentage  of  borrowing  tends  to  confirm  what 
has  already  been  said,  to  the  effect  that  abnormally 
small  borrowings  indicate  either  a  weak  or  a  misman- 
ajjcd  company. 

In  estimating  funds  in  the  Central  Leather  Company, 
it  would  not  be  improper  to  deduct  the  item  of  invest- 
ment, although  it  is  not  large  enough  to  make  any  ma- 
terial difference.  This  leaves  actual  funds  of  approxi- 
mately $121,000,000,  ar  •  t  borrowings  of  $20,800,000, 
about  80  per  cent. 

It  goes  without  saving  that  this  analysis  of  the  five 
balance  sheets  is  superficial  and  that  the  results  are 
merely  suggestive.  To  ascertain  the  exact  proi>ortion 
of  Wowed  to  owned  funds  in  each  case  we  should  have 
iust  to  learn  the  exact,  not  the  nominal,  value  of  the 


116 


CORPORATION  FLNANCE 


'£■' 


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i 


11 


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assets,  which  is  an  impracticable  task.  As  it  is  reason- 
ably certain  that  the  cost  in  every  case  is  less  than  the 
book  value  of  the  assets,  the  true  percentages  of  bor- 
rowed to  owned  funds  are  in  all  probability  greater  than 
the  ligures  given.  Four  out  of  these  five  corporations 
no  doubt  borrow  more  than  half  the  funds  they  use. 
Other  well-managed  companies  follow  the  same  prin- 
ciple. 

64.  Distribution  of  security  issues. — The  next  ques- 
tion to  consider  is:  What  issues  of  securities  or  credit 
instruments  should  a  corporation  put  out  and  what  pro- 
portion of  its  total  funds  should  be  obtained  by  each  of 
these  issues?  In  order  to  raise  fund«  from  each  of  the 
four  sources  outside  the  business  itself  named  above,  the 
corporation  manager  will  offer: 


SOURCES 

SECURITH 

(a) 

To  trade  creditors 

Bills  and  notes  p.    able 

(b) 

To  banks 

Notes    payable    and    en- 
dorsed notes  receivable 

(c) 

To  the  investing  pub- 

Mortgage bonds  a»  i  per- 

lic 

haps  preferred  stock 

(d) 

To    the    speculative 
public 

Stock. 

The  amount  of  each  security  offered  will  depend  in  part 
on  the  assets  and  in  part  on  the  earnings  of  the  corpo- 
ration. 

Corporate  assets  in  nearly  every  line  of  business  fall 
naturally  into  six  groups,  as  follows: 

(a)  Fixed  investments  essential  to  the  business,  such 
as  real  estate,  buildings  and  machinery  and,  in  the  case 
of  holding  companies,  securities  of  subsidiary  corpo- 
rations. 


SOURCES  OF  CORrORATE  FUNDS 


117 


(b)  Property  that  could  be  sold  without  breaking  up 
the  business,  though  the  sale  would  probably  be  at  a 
mavy  sacrifice,  such  as,  outlying  real  estate,  securities 
of  other  companies  control  of  which  is  not  essential  to 
tlie  integrity  of  the  corporation,  raw  materials,  and 
goods  in  process. 

(c)  Finished  products  on  hand. 

(d)  Accounts  receivable. 

(e)  Cash. 

(f)  Intangible    assets,    such    as    good-will,    trade 

marks,  etc. 

To  the  first  five  groups  roughly  correspond  obliga- 
tions for  borrowel  money,  as  follows: 

(a)  INIortgages  and  mortgage  bonds  obtainable  as  a 
rule  on  good  terms  up  to  60  to  75  per  cent  of  the 
appraised  value  of  real  estate;  50  per  cent  of  build- 
iii<rs;  25  to  40  per  cent  of  machinery;  50  to  90  per  cent 
of  securities. 

(b)  and  (c)  Income,  profit-sharing  and  car-trust 
l)()ii(ls,  on  a  great  variety  of  terms,  preferred  stock  in 
some  cases  and  to  some  extent  short-term  notes  and 

bank  loans. 

(d)  and  (e)   Accounts  payable  and  bank  loans. 

Group  (f)  and  the  differences  between  the  other 
assets  and  their  corresponding  liabilities  are  usually 
r.  presented  by  stock  issues  and  by  surpluses  The 
K  ader  will  understand,  no  doubt,  that  this  classification 
is  merely  approximate  and  is  not  always  followed  in 
l)ractice;  yet  an  analysis  of  balance  sheets  will  reveal, 
uri  the  whole,  a  close  adherence  by  corporation  mana- 
«i IS  to  the  principles  just  stated. 

In  all  industries,  more  or  less,  and  especially  in  rail- 
roads and  stable  manufacturing  concerns,  the  creditors 
of  the  corporation,  as  we  shall  see  later,  yay  more  at- 


118 


CORPORATION  FINANCE 


ill 

i  ; 


tention  to  the  income  account  than  to  the  balance  sheet. 
The  gross  earnings  of  any  corporation  are  necessarily 
devoted  to  the  following  purposes:  (1)  Operation; 
(2)  mahitenance ;  (3)  fixed  interest  charges  and  ren- 
tals; (4)  floating  interest  charges;  (.3)  betterment  and 
surplus;  (6)  dividends. 

The  stability  and  amount  of  the  earnings  will,  of 
course,  greatly  affect — in  fact,  determine  largely — the 
value  of  a  corporation's  assets,  and  in  that  way  will 
affect  the  amount  and  kind  of  securities  that  it  may 
wisely  issue. 

65.  Corporation  growth  and  hank  loans  in  Canada. 
— In  a  country  such  as  Canada,  where  industries  are 
expanding  at  such  a  rapid  rate,  the  relations  of  the 
banks  and  corporations  are  naturally  extensive.  Dur- 
ing one  of  the  recent  years,  no  less  than  4,651  new 
companies  secured  Dominion  or  provincial  charters. 
The  total  authorized  capitalization  of  these  companies 
was  $1,245,927,701.  The  largest  number  of  companies 
was  chartered  during  the  week  ended  September  21, 
when  158  federal  and  provincial  charters  were  granted. 
The  largest  aggregate  authorized  capitalization  for  one 
week  was  that  for  thd  week  ended  July  13,  whea  tlie 
figures  were  $137,231,000. 

The  following  table  shows  the  number  of  companies 
formed  in  Canada  during  the  year  above  mentioned, 
with  individual  capital  of  $1,000,000  or  more: 

Capital  ''n  Millions 

of  Dollars  Number  of  Companies 

1      U7 

U   28 

2     42 

2i   « 

a     14 


SOURCES  OF  CORPORATE  FUNDS  119 

Capital  in  Millions 

of  Dollars  Number  of  Companies 

3i   \ 

4      * 

4i   1 

5     1^ 

6     « 

6i    ^ 

^"    ? 

1«     i 

25     J 

80     ^ 

120     

According  to  the  census  of  manufactures  taken  by 
tlie  Dominion  government  in  1911  for  the  year  1910,  the 
cuDital  employed  by  4,568  industrial  estabhshn^nts  was 
$800,667,122.  The  increase  of  capital  employed  m 
Canada's  industries  in  the  ten  years  from  1890  to  1900 
was  34.76  per  cent;  in  the  decade  from  1900  to  1910, 
170.15  per  cent;  and  in  the  twenty  years,  1890  to  1910, 
276.10  per  cent.  These  few  figures  show  clearly  what 
a  large  amount  of  bank  financing  must  be  mvolved. 

66.  Attitude  of  Canadian  banfcer*.-In  the  course 
of  Sir  Edmund  Walker's  evidence  before  the  Ban^mg 
and  Commerce  Committee  at  Ottawa,  early  m  1918 
Hon.  Mr.  mite,  the  Canadian  Finance  Mmister,  asked 
him  if  it  was  good  banking  to  advance  money  on  securi- 
ties  of  new  enterprises  pending  the  sale  of    he  bonds 
Sir  Edmund  is  quoted  as  replying,  "Tt  ,s  qmte  proper^ 
in  fact,  the  industries  could  not  be  established  unless  this 
were  done."  .      , 

Sometimes  complaints  are  made  by  I"""™'"  *"^! 
Dominion  to  the  effect  that  the  funds  belonging  to  their 


120 


CORPORATION  FINANCE 


II 

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11,  ii 


communities  are  drawn  to  the  monetary  centers  and 
there  used  as  loans  to  underwriters,  promoters  and 
others  engaged  in  the  practice  of  high  finance.  But 
many  of  the  large  factories  or  industries  located  in 
suburban  districts  and  country  towns  could  not  have 
been  built  unless  the  facilities  for  financing  the  under- 
writing operations  had  been  available.  Mr.  White's 
question  seemed  to  indicate  that  there  is  some  difference 
of  opinion  among  Canadian  bankers  as  to  whether  the 
chartereu  banks  should  engage  extensively,  in  this  way, 
in  the  promotion  of  new  industrial  companies. 

Wlien  a  Canadian  bank  participates  in  the  flotation 
of  a  large  issue  of  this  kind,  and  the  securities  are  taken 
at  once  by  the  public,  it,  in  company  with  the  other  un- 
derwriters, receives  the  prearranged  commission,  without 
being  under  obligation  to  take  up  any  of  the  securities. 
Even  in  that  case  the  bank  will  very  likely  be  obliged  to 
make  loans  to  brokers  on  security  of  tlie  newly  issued 
bonds.  If  the  bank  has  the  account  of  the  promoters  of 
the  enterprise,  it  will  probably  be  required  to  make  ex- 
tensive loans  to  them  prior  to  the  public  flotation.  Some 
part  of  these  loans  would  remain  on  the  books  after  the 
flotation.  This  is  what  may  be  expected  even  when  the 
flotation  is  entirely  successful.  Circumstances  are  not 
so  comfortable  for  the  bank  when  the  issue  is  only  a  par- 
tial success;  and  they  may  be  decidedly  uncomfortable 
if  the  flotation  proves  to  be  a  flat  failure.  When  the 
public  does  not  take  the  securities,  the  bank,  as  one  of  the 
underwriters,  must  take  its  proportion  of  the  unsold 
securities.  It  may  have  to  make  loans  to  other  under- 
writers to  enable  them  to  take  up  their  loans  also.  When 
a  broker  or  other  financier  enters  an  underwriting  syn- 
dicate, he  does  not  usually  contemplate  putting  any  of 
his  own  fimds  or  capital  intr  the  venture,  even  if  the  flo- 


SOURCES  OF  CORrORATE  FUNDS 


121 


tation  proves  to  be  a  failure.  He  will  eount  upon  bor- 
1  owing  the  requisite  amount  from  his  bankers;  and  he 
^^\\\  perhaps  expect  the  bank  to  carry  the  loan  until  the 
syndicate  succeeds  in  finally  disposing  of  the  issue.  If 
tiie  securities  do  not  sell  rapidly,  the  bank  may  have  the 
underwriters'  loans  on  its  hands  for  long  terms.  They 
will  not,  perhaps,  offer  to  reduce  the  loans— except  as 
the  securities  are  sold— and  if  the  banker  suggests  re- 
ductions they  may  not  receive  his  suggestion  kindly. 

(17.  How  tJie  Canadian  hank  makes  loans  to  corpora- 
tions--The  supervision  of  loans  and  credits  by  the  Ca- 
nadian banks  obviously  involves  great  responsibility. 
We  may  explain  here  the  system  of  one  Canadian  bank 
which  has  been  successfully  carried  on  for  several  years. 
The  borrower  is  expected  to  have  only  one  banker,  or,  if 
the  account  is  very  large  and  there  are  two  or  more 
hankers,  there  is  a  clear  agreement  as  to  their  respective 
shares  of  the  bank  advances.     A  bank  credit  is  never 
established  for  more  than  one  year,  and  expires  on  a 
particular  day.    The  manager  in  charge  of  the  account 
is  expected  to  arrange  for  its  renewal  before  the  date  of 
(xi)iry.    If  this  is  not  done,  the  account  falls  automatic- 
ally into  the  irregular  class  and  is  under  the  eye  of  the 
s.ij)erintendent's  department  until  the  credit  is  re-estab- 
lished.   A  new  credit  or  the  renewal  of  a  credit  will  not 
Ik  considered  unless  the  balance  sheet  for  the  year  is  sub- 
itted,  together  with  as  full  a  statement  of  profit  and 
ss  as  is  obtainable.     This  procedure  refers  only  to 
(1  edits  involving  direct  advances  not  secured  by  securi- 
ties or  by  bills  of  other  parties  for  merchandise  sold. 

Wn^en  the  practice  of  demanding  a  balance  sheet  from 
every  customer  who  desired  direct  loans  was  put  into 
..peration,  it  was  said  that  it  would  not  succeed.  But  it 
has  been  found  that,  no  matter  how  wealthy  the  cus- 


nii 


los* 


122 


CORPORATION  FINANCE 


■  U 


.i  t 


tomer  may  be,  he  can  be  induced  to  give  his  full  con- 
fidence to  the  banker  from  whom  he  is,  through  his 
application  for  credit,  asking  practically  the  same  thing. 
In  lending  funds  for  the  entire  requirements  of  a  tim- 
ber business,  for  instance,  where  a  large  expenditure  in 
the  forest  precedes  extensive  milling  operations,  sums 
are  advanced,  sometimes  with  no  other  security  than  the 
mere  obligation  of  the  customer.  This  would  seem  dan- 
gerous even  to  the  conservative  English  banker.  The 
basis  for  the  credit  may  be  mainly  the  expenditure  of 
a  bank  over  a  series  of  years,  during  which  every  pay- 
ment out  of  the  business  and  all  receipts  for  merchan- 
dise sold  pass  through  the  bank  account.  Each  year  the 
balance  sheet  is  presented,  and  many  of  its  features  can 
be  roughly  verified  by  the  bank  account  itself. 

The  branch  manager  is  expected  to  revalue  the  items 
in  the  balance  sheet  and  to  analyze  it  so  as  to  separate 
the  liquid  from  the  fixed  assets.  If  the  liquid  capital— 
that  is  the  surplus  of  liquid  assets  over  the  floating  debts 
— is  not  sufficient  to  warrant  the  belief  that  once  a  year 
the  loans  will  be  paid  in  full,  the  credit  requires,  at  least, 
unusual  justification. 

There  are  some  trades  in  which  the  payment  of  ad- 
vances once  a  year  would  not  be  wise  or  natural,  but  the 
bank  authorities  have  been  greatly  surprised  at  the 
extent  to  which,  in  the  past  five  or  ten  years,  they  have 
succeeded  in  establishing  this  as  a  most  important  factor 
in  credits. 

68.  Bank  loans  and  credits. — Sir  Edmund  Walker, 
president  of  the  Canadian  Bank  of  Commerce,  in  an 
address  on  Banking  in  Canada,  before  the  London  In- 
stitute of  Bankers,  said: 

Apart  from  the  transactions  in  New  YorV  or  at  other  points, 
whciP  that  portion  of  our  reserves  which  may  safely  be  placed 


SOURCES  OF  CORrORxVTE  FUNDS 


128 


In  call  or  on  short  loans  on  securities  is  carried,  the  Canadmn 
banking  business  is  more  closely  akin  to  tlie  banking  of  the 
.,,ai„ary  cities,  towns  and  villages  in  England  than  to  that  of 
London.    There  are  practically  no  acceptances  by  other  banks 
or  by  wealthy  merchants,  against  shipment  of  merchand.se  to 
Canada,  offered  for  discount.     In  the  main  it  is  a  case  of 
establishing  a  credit  for  the  working  of  a  particular  busmess. 
1  do  not  know  what  may  be  the  opinion  of  outsiders  regardmg 
the  carefulness  or  otherwise  with  which  the  lending  operations 
of  Canadian  banks  are  carried  on.    It  is  a  time  of  great  expan- 
sion and  it  might  be  natural  to  suppose  that  the  requirements 
of  customers  would  be  vaguely  considered  and  the  relations 
Ixtween  banker  and  customer  ill-defined  and  sometimes  beyond 
the  control  of  the  banker.     Doubtless,  there  is  a  considerable 
percentage  of  bad  banking  in  Canada,  as  in  other  countries, 
hut  I  doubt  whether  banks  in  any  country  are  as  a  rule  more 
explicit  in  the  establishment  of  credits  or  do  so  upon  more 
complete  information. 

We  are,  fortunately,  forbidden  from  lending  on  real  prop- 
.  rty,  although  it  may  be  taken  as  security  for  an  existing  debt, 
and  long  experience  has  taught  the  Canadian  banker  to  beware 
of  advances  which  rest  even  partially  upon  the  plant  or  buUd- 
i„ffs  or  any  of  the  fixed  assets  of  the  borrower.     In  other 
countries  such  banking  may  be  both  safe  and  wise,  but  our 
policy  is  to  lend  by  established  credits  only  the  money  neces- 
sary to  produce  and  carry  the  merchandise  to  market.    Now, 
if  a  customer  deals  with  only  one  bank,  pays  for  all  materials 
and  labor  in  cash,  makes  all  payments  by  checks  on  his  bank, 
exhibits  once  a  year  his  balance  sheet  and  profits,  and  at  the 
same  time  discusses  at  length  the  various  features  of  his  busi- 
ness for  the  purpose  of  having  his  credit  re-established,  it  is  not 
.Ufficult  to  lend  him  very  large  sums  with  safety.    In  addition 
to  the  analysis  of  the  balance  sheet,  comparisons  are  made  with 
several  previous  years,  and  as  all  correspondence  is  conducted 
on  special  forms  with  only  one  subject  on  each  form,  and  every- 
thing is  typewritten— the  carbon  copies  of  one  side  of  the  cor- 
respondence being  filed  with  the  originals  of  the  other  side— 


124. 


CORPORATION'  FINANCE 


t   *    '   - 

if     \ 


:  i    i 


the  banker  can  in  a  moment  have  before  him  in  the  correspond- 
ence and  the  analyzed  balance  sheet,  practically  all  that  he 
needs  to  know.  All  except  the  quite  small  credits  are  discussed 
with  the  boards  of  directors,  and  the  system  makes  it  possible 
to  deal  with  a  large  number  of  credits  at  each  sitting. 

The  growth  of  the  loans  of  the  Canadian  banks  is 
shown  by  the  following  figures: 

1867  $  55,469,521 

1870  78,095,144 

1880  125,555,284. 

1890  202,518,727 

1900  362,004,795 

1910  880,857,520 

1912  881,331,981 


f  i 


CHAPTER  VIII 


SHORT-TIME  LOANS 

69.  Trade  credit  as  a  source  of  funds.— The  preceding 
chapter  named,  without  describing,  the  three  forms  m 
^^  hich  corporations  incur  short-term  or  medium-term  ob- 
ligations, namely,  trade  credit,  bank  loans  and  notes  sold 
to  the  public.    We  will  now  take  up  each  of  these  forms 
ill  turn  and  see  what  we  can  discover  as  to  the  principles 
tliat  should  govern  their  use.    Readers  of  this  volume 
who  are  themselves  engaged  in  an  unincorporated  busi- 
ness will  perhaps  read  what  is  said  as  to  the  first  two 
forms  named  with  a  more  lively  interest  if  they  reflect 
that  the  principles  laid  down  apply  to  partnerships  or 
to  individual  proprietorships  as  well  as  to  corporations. 
The  funds  raised  from  the  trade  creditors  of  a  cor- 
poration are  secured  simply  by  buying  goods  on  credit. 
It  is  not  customary  in  most  lines  of  business  to  demand 
cash  immediately  on  delivery  of  goods,  except  from 
concerns  that  are  considered  untrustworthy.     Thirty 
(lavs  is  usually  allowed  before  trade  cr-ditors  begm  to 
press  for  payment  and  a  company  whose  business  is 
worth  having  can  often  considerably  lengthen  the  aver- 
age time  of  settlement,  if  that  policy  proves  desirable. 
In  some  lines-especially  when  the  sales  are  m  large 
lots— sixty  to  ninety  days,  or  even  six  months,  is  the 
usual  allowance.     For  sixty  days  or  over  the  debtor 
company  generally  gives  a  formal  promissory  note  or 
else  accepts  a  time  draft  which  amounts  to  about  the 

same  thing. 

125 


12G 


CORPORATION  FINANCE 


ni 


As  was  indicated  in  Chapter  VII,  it  is  good  business 
policy  for  a  company  to  take  as  much  trade  credit  as  it 
can  get  on  advantageous  terms  ar.^  with  safety.  These 
two  qualifications  are  worth  elaborating.  A  company 
does  not  obtain  trade  credit  on  advantageous  terms: 
(a)  when  by  so  doing  it  acquires  a  reputation  for  "slow 
pay"  which  makes  dealers  imwilling  to  quote  to  the 
company  their  lowest  prices;  (b)  when  by  so  doing  it 
loses  the  benefit  of  cash  discounts  larger  than  the  pre- 
vailing discount  on  bank  loans, — provided  in  this  case 
that  the  company  is  not  already  borrowing  as  much  as  it 
should  from  banks.  A  company  cannot  accept  trade 
credit  with  safety  when  by  so  doing  its  short-time  lia- 
bilities are  brought  up  nearly  equal  to  its  quick  assets. 
Notice  that  the  relation  is  not  between  total  liabilities 
and  total  assets,  but  between  quick  liabilities  and  quick 
assets.  A  concern  must  have  cash  funds  at  hand  to 
meet  its  accounts  and  bills  payable  when  due  and  no 
other  assets,  no  matter  how  valuable,  will  serve  the  pur- 
pose. A  failure  to  realize  just  that  simple  fact  has  been 
responsible  for  many  an  unnecessary  bankruptcy. 

Taking  the  five  balance  sheets  previously  referred  to 
(see  pages  112-114),  we  find: 

(1)  That  on  the  date  of  the  balance  sheet  the  quick 
liabilities  of  the  Herring-Hall-Marvin  Safe  Company 
were  about  100  per  cent  of  quick  assets  and  about  33 
per  cent  of  all  the  current  assets,  including  stocks,  work 
in  process  and  materials. 

(2)  That  the  corresponding  percentages  for  the 
American  Thread  Company  were  .58  per  cent  and  18 
per  cent.  (Current  liabilities,  including  debt  to  English 
Sewing  Cotton  Company,  in  proportion  to  current 
assets,  including  stocks,  investments  and  advance  pay- 
ments.) 


SHORT-TIME  LOANS 


127 


( 3 )  That  the  corresponding  percentages  for  the  Beth- 
lehem Steel  Company  were  81  per  cent  and  42  per  cent. 

(4)  That  the  corresponding  percentages  for  A. 
Booth  and  Company  were  83  per  cent  and  64  per  cent. 

(.3)  That  the  corresponding  percentages  for  the 
Central  Leather  Company  were  34  per  cent  and  6 
per  cent. 

We  may  infer  from  these  five  representative  balance 
sheets  that  a  conservative  company  will  not,  as  a  rule, 
allow  its  accounts,  bills  and  notes  payable  to  run  much 
ever  7.5  to  80  per  cent  of  its  quick  assets.     This  per- 
centage is,  in  fact,  not  far  from  normal.    It  would  be 
foolish  to  try  to  lay  down  any  absolute  rule  where  so 
much  depends  on  the  custom  of  each  line  of  busmess, 
„n  the  seasons,  on  the  nature  of  the  company's  assets,  on 
the  ease  with  which  bank  credits  may  be  secured,  and 
„n  the  general  commercial  outlook.    Enough  has  been 
said  to  indicate  that  trade  credit,  though  a  necessity 
to  nearly  every  successful  corporation,  may  become  too 
extensive.    Further  discussion  of  this  important  phase 
of  corporation  finance  must  be  deferred  imtil  we  begm 
a  study  of  the  financial  ma     gement  of  corporations. 

70  What  reliance  should  he  placed  on  hanh  loans?— 
Bank  loans  are  not  usually  to  be  had  except  on  first- 
class  security  and  for  short  periods.  Perhaps  the  best 
method  of  considering  the  advantages  and  disadvan- 
tages of  bank  loans  will  be  to  run  over  hastily  the  de- 
tailed statements  which  many  conservative  banks  now 
require  applicants  for  loans  to  file  with  them.  A  blank 
form  of  such  statements,  adopted  by  the  New  York 
State  Bankers'  Association,  and  widely  used,  is  pre- 
sented on  pages  *8-lti9.  Let  us  see  how  criticaUy  a 
hanker  will  examine  one  of  these  statements  when  pre- 
sented by  a  corporation  with  which  he  is  not  thoroughly 


128 


COUPOUATION  FINANCE 


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SHORT-TIME  LOANS 


129 


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CORPORATION  FINANCE 


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familiar.  Wliat  is  said  on  this  point  is  largely  based 
on  an  article  by  Mr.  William  Post,  Cashier  of  the 
Central  National  Bank  of  Philadelphia,  in  The  Journal 
of  Accountancy,  Volume  1,  page  181. 

Take  first  the  item,  "notes  receivable.'*  In  most 
lines  of  business  notes  are  little  given  except  by  weak 
concerns,  and  a  large  amount  of  "notes  receivable"  out- 
standing, therefore,  may  indicate  that  a  corporation  has 
been  in  the  habit  of  granting  unsafe  credits.  Some  of 
the  principal  lines  in  which  note  giving  is  still  common 
are  harvesting  machines,  plumbers'  supplies  and  electric 
trolley  supplies.  Where  notes  are  received  to  any  con- 
siderable extent  they  are  generally  discoimted  at  once 
by  well-managed  corporations.  Corporations  which 
show  a  large  figure  under  this  heading  of  "notes  re- 
ceivable," therefore,  would  be  regarded  by  the  banker 
with  distrust. 

"Notes  >»nd  accounts  receivable  of  officers,"  except 
in  insignificant  amounts,  would  naturally  arouse  suspi- 
cion. Ordinarily  officers  of  corporations  are  expected 
to  keep  their  personal  obligations  and  the  company 
funds  entirely  separate. 

The  valuation  of  merchandise  should  be  made  by 
means  of  an  expert's  inventory.  In  connection  with 
these  items  a  careful  banker  will  take  into  consideration 
the  possibility  of  extensive  fluctuations  in  value,  partic- 
ularly in  the  case  of  staple  articles  such  as  pig  iron, 
cotton,  wool  and  metal. 

The  other  assets  specified  are  not  of  immediate  in- 
terest to  the  banker,  because  they  will  not  ordinarily  be 
sold  to  meet  short-time  obligations.  They  may  be  con- 
sidered, however,  as  a  final  protection  to  the  banker  in 
case  the  concern  should  go  into  bankruptcy. 

Mr.  Post  suggests,  "that  in  estimating  the  value  of 


SHORT-TIME  LOANS 


131 


plants,  a  sharp  distinction  should  be  made  between 
Ixiildings  used  for  manufacturing  and  for  merchandis- 
ing purposes.  A  business  structure,  conveniently  lo- 
cated for  trade,  is  a  good  asset.  It  is  not  adapted 
specially  to  any  one  purpose.  Even  if  the  business 
vliieh  now  occupies  it  should  be  withdrawn,  it  could  be 
sold  and  applied  to  some  other  use.  Its  value  can  be 
easily  appraised.  The  banker  is  justified,  therefore,  in 
placing  a  high  net  value  upon  such  property  when  well 
locatetl.  With  the  manufacturing  plant,  however,  the 
situation  is  entirely  different.  The  whole  building  is 
often  specialized  to  some  particular  use:  if  the  busi- 
ness fails,  it  is  very  difficult  to  apply  the  premises  to 
otlier  purposes."  Machinery  is  even  less  salable,  as 
a  rule,  than  a  manufacturing  building.  In  general,  a 
concern  that  is  not  making  a  success  of  its  undertaking 
^\  ill  very  seldom  find  buyers,  except  at  a  very  heavy 
sacrifice,  for  its  fixed  assets. 

Turning  to  the  liabilities,  we  have  already  laid  down 
the  rule  that  "notes  payable"  given  for  merchandise, 
except  in  the  few  lines  of  business  specified  above,  are 
not  required  from  first-class  concerns.  "The  second 
and  third  items,"  says  Mr.  Post,  "are  distinguished  in 
ortler  to  show  how  much  paper  a  concern  may  have  with 
its  own  banks  and  how  much  it  may  have  negotiated 
through  a  note  broker.  It  is  quite  important  to  the 
hanker  to  know  how  much  paper  a  borrower  has  sold, 
as  the  saying  is,  'on  the  street.'  If  he  finds  that  the 
horrower  is  choking  his  bank  account  and  at  the  same 
time  putting  a  large  amount  of  paper  out  into  the  open 
ni;irket,  the  ])nnker  is  likely  to  arrive  at  the  conclusion 
Ticit  the  borrower  is  not  keeping  available  any  partic- 
ular resource  or  channel  which  he  could  utilize  in  case  of 
a  stringency  in  the  money  market.    It  is  a  fixed  rule 


132 


CORPORATION   FINANCE 


Ill  h 


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i 


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#4 


of  financial  management  that  a  concern  should  not 
borrow  largely  at  its  bank  and  at  the  same  time  sell 
large  amounts  of  its  paper  in  the  market.  If  the  bank 
line  is  full,  paper  should  not  be  upon  the  street ;  if  made 
largely  for  the  street,  then  the  bank  should  be  kept 
open." 

"Accounts  payable"  is  to  be  considered,  of  course,  in 
contrast  to  "accounts  receivable"  and  the  propor- 
tions already  mentioned  in  this  chapter  should  be  ob- 
served. 

Ordinarily  only  close  corporations  would  have  any 
deposits  made  with  them  by  individuals.  Wliere  there 
are  such  deposits  they  would  be  regarded  as  a  possible 
source  of  danger,  since  the  persons  who  make  them  are 
r.pt  to  be  in  close  touch  with  the  management  and  to  be 
informed  of  any  impending  trouble  in  time  to  protect 
themselves — possibly  at  the  expense  of  the  other 
creditors. 

Bond  and  mortgage  debts  should,  of  course,  be  pro- 
portioned to  the  fixed  assets  of  the  corporation.  The 
mortgage  should  be  very  carefully  examined  in  order 
to  make  sure  that  it  does  not  cover  more  than  the  fixed 
assets.  Sometimes  a  real  estate  mortgage  will  contain 
a  clause  making  it  a  first  lien  also  on  the  chattels  or 
quick  assets  of  the  corporation.  Chattel  mortgages  are 
unusual  and  do  not  often  exist  unless  a  corporation  is 
already  in  serious  straits. 

A  large  amoimt  of  contingent  liabilities  would  be 
regarded  as  a  weakness.  Especially  is  this  true  of  the 
item  "other  contingent  liability,"  which  refers  to  en- 
<lorsement  of  outside  paper  and  to  miscellaneous  obli- 
gations. 

Generally  speaking,  a  corporation  is  not  expected  to 
assign  its  accounts  receivable.     There  may  be  well- 


SIIOUT-TIME  LOANS 


133 


grounded  exceptions  to  tliis  rule  but  the  exceptions 
require  explanation. 

The  item  "other  assets  used  as  collateral"  would  be 
filled  out  normally  only  by  commission  houses  among 
which  the  custom  is  to  put  up  bills  of  lading  or  ware- 
house receipts  as  collateral  for  loans.  In  the  United 
States  a  manufacturing  company  is  not  expected  to 
pledge  any  specific  asset  except  its  fixed  capital.  In 
Canada  and  in  Europe  manufacturers  obtain  funds  from 
banks  upon  pledge  of  raw  material  and  finished  products. 

The  banker  wants  to  be  sure  that  a  corporation  is 
carrying  sufficient  insurance;  otherwise  a  fire  or  some 
other  accident  may  make  the  assets  almost  valueless. 

The  items  under  the  head  "business  and  results"  are 
important,  inasmuch  as  they  tell  the  banker  to  what 
extent  the  company  may  meet  its  obligations  out  of 
iiit'ome.  An  expert  in  any  particular  business  can  tell 
very  often  by  an  inspection  of  these  items  whether  the 
company  is  well-managed  or  not,  for  he  will  know  how 
large  should  be  the  percentages  of  gross  profits  and 
of  net  profits  to  sales.  It  is  very  difficult  for  an  out- 
sider to  form  any  sound  judgment  on  this  point. 
"Dividends  paid"  will  indicate  how  conservative  the 
corporation  is  in  providing  against  possible  future 
losses.  The  item  of  "bad  debts"  obviously  shows  how 
carefully  the  corporation  looks  after  its  credits. 

The  succeeding  items  are  intended  to  answer  ques- 
tions with  regard  to  the  balance  sheet  or  profit  and  loss 
statement.  The  banker  will,  of  course,  observe  very 
caiefully  what  assets  are  covered  by  outstanding 
mortgages  and  bonds.  He  wants  to  know  what  bank 
accmmts  are  kept  other  than  those  named  in  the  balance 
sheet,  because  some  concerns  may  keep  additional  secret 
hank  accounts  with  the  idea  of  inducing  the  bankers 


134 


CORPORATION  FINANCE 


to  favor  them  with  loans.  A  knowledge  of  the  average 
terms  on  which  goods  are  bought  and  sold  enables  the 
banker  to  form  an  idea  as  to  how  pressing  the  corpora- 
tion's accounts  payable  and  as  to  how  "quick"  its  ac- 
counts receivable  are.  By  learning  the  time  of  year 
when  accounts  receivable,  stocks  of  merchandise  and 
liabilities  are  at  their  maxima  and  minima,  the  banker 
may  better  judge  as  to  whether  the  balance  sheet  repre- 
sents the  normal  condition  of  the  corporation  or  not. 

It  goes  without  saying  that  to  have  the  statement 
based  on  an  actual  inventory  and  to  have  it  audited,  be- 
fore presentation,  by  a  certified  public  accountant,  will 
add  greatly  to  its  value  in  the  eyes  of  any  banker. 

We  have  gone  over  this  blank  form  at  some  length 
for  two  purposes:  First,  because  it  illustrates  how  a 
corporation's  statement  may  be  analyzed  and  how  much 
information  may  be  extracted  from  it;  second,  because 
it  shows  how  strict  and  careful  conservative  bankers 
are  in  granting  loans.  The  writer  does  not  mean  to  say 
that  every  concern  which  borrows  money  from  a  bank 
presents  such  a  detailed  statement  and  has  it  so  closely 
analyzed  as  what  has  been  said  may  indicate.  It  is  true, 
however,  that  the  custom  of  demanding  and  of 
thoroughly  inspecting  such  statements  is  growing.  It 
is  also  true  that  a  conservative  corporation  will  not  de- 
sire bank  loans  unless  it  can  present  a  statement  that 
would  meet  with  the  approval  of  any  careful  banker. 

71.  Note8  sold  to  the  public  as  a  source  of  funds. — 
Promissory  notes  of  a  corporation  may  be  given  in  order 
to  raise  funds  from  (a)  concerns  which  supply  mer- 
chandise, (b)  banks  or  (c)  the  public.  We  have  al- 
ready seen  how  and  to  what  extent  they  may  be  issued 
in  the  first  two  cases :  we  have  now  to  consider  the  third 


case. 


SHORT-TIME  LOANS 


185 


The  form  of  the  note  is  substantially  the  same  in  all 
three  uses.    It  is  a  simple  promise  to  pay  and  must  con- 
tain the  features  that  are  essential  to  call  valid  negotiable 
notes,  which  are:  (a)  two  parties  to  the  contract,  (b) 
transferability,  (c)  a  definite  sum  of  money,  (d)  definite 
dav  of  payment,  and  (e)  proper  signature.    It  is  worth 
noting  here  that  as  a  general  rule  the  power  to  bind 
a  corporation  in  this  manner  does  not  belong  to  an 
officer  unless  it  is  expressly  conferred  on  him.    Never- 
theless, the  note  of  a  corporation  signed  and  in  the  hands 
of  an  innocent  holder  for  value  is  usually  binding,  even 
if  the  signer  acted  beyond  his  powers.     Technical  ob- 
jections to  a  note,  based  on  its  unproper  execution  or 
on  unauthorized  uses  of  the  money  borrowed,  are  not 
usually  upheld.    It  is  worth  noting  also  that  the  cor- 
poration signature  should  be  used.     Notes  signed  by 
officers  in  their  own  names,  even  if  their  corporate  titles 
are  given,  or  notes  containing  such  words  as    jointly 
and  severally  promise  to  pay"  may  be  held  as  personal 

obligations.  . 

The  usual,  although  not  a  necessary,  distinction  be- 
tweent  notes  given  in  the  ordinary  course  of  trade  or  to 
banks  and  notes  sold  to  the  public  is  in  the  length  of 
time  of  the  debt.  In  the  first-named  cases  they  do  not 
nsually  run  over  six  months.  Notes  sold  to  the  public 
are  more  likely  to  run  from  one  to  ten  years.  Two 
or  three  years  is  about  the  average  period,  interinediate 
between  sixty-days  to  six  months  notes,  on  the  one 
hand,  and  ten  to  one-hundred-year  bonds,  on  the  other 
hand.  They  are  issued  in  denominations  varying  from 
$100  to  as  high  as  $100,000. 

The  chief  objection  to  these  instruments  is  that  they 
do  not  appeal  to  any  large  dependable  body  of  pur- 
chasers.    The  commercial  banks  do  not  care  for  them 


186 


CORPORATION  FINANCE 


:' 


because  they  are  not  "quick"  enough.  Comparatively 
few  individual  investors  will  buy  them  because  they 
are  to  be  cancelled  within  a  comparatively  short  period, 
and  the  average  individual  investor  does  not  choose  to 
watch  his  investments  closely  and  renew  them  fre- 
quently. His  idea,  on  the  contrary,  is  to  get  hold  of 
a  safe  security  that  yields  a  steady  return  and  to  keep 
it  indefinitely.  The  market  for  medium-term  notes, 
therefore,  is  restricted,  generally  speaking,  to  persons 
of  large  means  who  are  in  fairly  close  touch  with  the 
financial  world  and  who  happen  to  have  idle  funds  on 
hand.  Such  persons  are  most  easily  reached  through 
the  big  financial  houses  and  these  houses  almost  invari- 
ably absorb  note  issues  of  any  size  and  distribute  them 
to  their  clients. 

On  account  of  the  limitations  of  the  market  it  is 
always  difficult  to  tell  in  advance  whether  an  issue  of 
medium-term  notes  will  be  taken  up  by  the  public  or 
not.  It  is  still  more  difficult — in  fact,  impossible — to 
tell  at  the  time  of  issue  whether  the  notes  can  be  readily 
renewed  when  the  time  of  payment  arrives.  Xo  con- 
servative corporation  manager  will  put  out  such  notes 
unless  he  has  first  provided  for  their  payment  when 
due.  This  he  may  do  in  two  ways :  either  by  saving  the 
necessary  amount  out  of  the  corporation's  income  or  by 
securing  through  bond  issues  the  funds  with  which  to 
pay  off  the  notes.  The  first  course  involves  cutting 
down  the  borrowings  of  the  corporation  which,  as  has 
been  pointed  out,  is  likely  to  be  undesirable.  Ordinarily 
the  second  course  would  be  inadvisable,  for  if  bonds 
are  to  be  put  out  at  all  they  might  as  well  be  issued  in 
the  first  place. 

This  suggests  the  usual  reason  for  the  issue  of  notes 
to  the  public,  namely,  as  a  temporary  expedient  when 


SHORT-TIME  LOANS 


137 


a  bond  issue  is  for  the  time  being  deferred.     Some- 
times a  raUroad  is  building  a  new  branch  or  a  manu- 
facturing company  is  putting  up  a  new  buQding  on 
which  an  issue  of  bonds  is  to  be  based.    In  the  mean- 
time medium-term  notes  may  be  issued  to  secure  funds 
for  construction.    Again,  a  company  in  need  of  funds 
may  find  the  general  financial  situation  unfavorable  to 
a  bond  issue  and  may  put  out  notes  with  the  intention 
of  selling  bonds  before  the  notes  come  due.    The  prac- 
tice, though  often  justifiable,  is  always  more  or  less 
risky.    In  AprU,  1907,  for  instance,  the  Erie  Railroad 
issued,  for  that  reason,  $5,500,000  of  one  year  notes. 
In  April,  1908,  the  conditions  being  still  unfavorable, 
the  railroad  authorized  an  issue  of  $15,000,000  three 
year  notes,  of  which  $5,500,000  were  exchanged  at  par 
for  the  first  issue.    In  July,  1907,  the  Bethlehem  Steel 
Company  issued  $1,187,000  of  6  per  cent  serial  three, 
four,  and  five  year  notes,  apparently  for  the  same 
reason.     In  October,  1906,  the  American  Locomotive 
Company  issued  $5,000,000  of  one  to  five  year  notes 
for  the  purpose  of  paying  floating  indebtedness  and  of 
providing  working  capital.     It  is  expected  that  these 
notes  will  be  redeemed  out  of  income.    These  examples 
will  indicate  roughly  when  and  how  medium-term  notes 
are  issued. 

Although  notes  for  the  public  are  generally  simply 
unsecured  promises  to  pay,  ihey  may,  especially  for  the 
h)nger  terms,  be  based  on  certain  definite  property.  A 
corporation's  holdings  of  securities  of  other  companies 
are  frequently  put  up  under  mortgage  as  collateral 
scctnity.  It  is  difficult  to  draw  a  line  between  long- 
tiine  collateral  trust  notes  and  short-time  collateral 
trust  bonds;  in  fact,  notes  and  bonds  merge  into  each 


13K 


CORPORATION  FINANCE 


other  and  the  distinction  between  them  is  in  some  cases 
merely  nominal. 

In  this  chapter  we  have  been  dealing  with  the  current 
obligations  of  corporations.  The  main  point  with  re- 
gard to  them  to  bear  in  mind  is  that  they  ought  to  be 
offset,  if  they  are  to  be  made  good,  by  a  more  than 
equal  amount  of  current  assets,  and  no  other  kind  of 
assets  will  serve  the  purpose.  To  issue  notes  and  put 
the  funds  thus  secured  into  fixed  or  semi-fixed  assets 
without  having  on  hand  a  large  surplus  of  current 
assets  is  unsound  and  dangerous  financing. 

72.  Canada's  short-term  loans. — ^While  short-term 
loans  have  been  comparatively  common  during  recent 
years  in  the  United  States,  it  was  only  during  1912  and 
1913  that  they  commenced  to  appear  as  an  important 
factor  in  Canadian  finance.  At  that  time,  too,  the  issues 
of  such  securities  by  United  States  corporations  were 
unusually  numerous.  Canadian  provincial  governments 
and  municipalities  were  among  the  first  to  utilize  this 
method  of  financing.  In  1913,  the  movement  spread  to 
the  Canadian  railroads  and  both  the  Grand  Trunk  and 
Canadian  Northern  Railway  Companies  made  such  is- 
sues. One  of  the  Grand  Trunk  issues  is  discussed  else- 
where in  this  volume. 

This  form  of  financing  is  evidently  becoming  popular 
among  corporations  and,  obviously,  especially  so  in 
times  of  financial  stringency,  ^stating  that  out  of  a 
total  of  $180,000,000  new  security  issues  in  the  United 
States  $135,000,000  consisted  of  short-term  notes  and 
that  a  year  previously  the  June  issues  aggregated  $299,- 
000,000  of  which  only  $83,000,000  were  short-term 
notes,  the  New  York  Journal  of  Commerce  cooamented 
as  follows: 


SHORT-TIME  LOANS 


139 


Tins  phenomenal  increase  in  short-term  notes,  which  are 
l,,..ly  floating  debt,  should  arrest  attention.  It  jUustra  es 
very  plainly  not  only  the  urgent  demands  for  capital,  but  also 

the  difficulty  of  satisfying  them. 

«     •     *     ♦     • 

This  is  one  of  the  evidences  of  th-  diminution  in  the  avail- 
able supply  of  accumulated  capital  often  referred  to  Another 
striking  fact  is  that  more  than  the  entire  reduction  in  the  amount 
taken  up  in  new  investments  pertains  to  industrial  securities. 

«     ♦     ♦     *     • 

These  notes  are  put  out  for  short  time  at  high  rates  because 
the  capital  cannot  be  obtained  on  better  terms.  They  are  not 
issued  in  any  considerable  proportion  for  temporary  purpose  „ 
but  in  the  expectation,  or  at  least  in  the  hope,  that  when  they 
mature  they  can  be  replaced  with  long-term  obligations  at  lower 
rates.  This  is  a  matter  of  expectation  and  hope  and  not  of 
calculation,  and  it  is  significant  of  uncertain  conditions  and  a 
waiting  policy. 

While  short-time  loans  have  been  familiar  to  Wall 
Street  and  Lombard  Street  fo  some  years,  it  would 
seem  that  this  form  of  borrowing  is  being  regarded  with 
less  favor,  and  possibly  corporations  will  find  some  dif- 
ficulty in  the  future  in  adopting  this  method  of  securing 
funds.    Among  the  first  loans  raised  by  the  British 
Treasury  after  the  Revolution  of   1688  was  one  by 
means  of  Exchequer  BUls,  but  it  was  not  a  success;  in 
subsequent  years  it  became  the  constant  practice  of  the 
British  Government  to  anticipate  revenue  by  means  of 
such  securities.    Exchequer  Bonds  were  fi^s*  isf"ed  in 
1853,  but  after  the  first  issue  of  Treasury  Bills  m  1877 
the  former  method  fell  into  disuse,  with  the  exception 
of  the  issue  in  1889.   It  was  revived  again,  however,  dur- 
ing the  South  African  War  and  is  now  the  usual  form 
adopted  when  raising  money  for  particular  purposes 

where  the  liability  should  cease  in  a  short  term  of  years. 


140 


CORPORxVTION  FINANCE 


I 
I 

i 


I 


. 


Treasury  Bills  are  issued  each  year  and  care  is  taken  by 
the  Finance  Department  to  see  that  their  authority  to 
raise  money  in  this  manner  does  not  lapse  through  non- 
use. 

The  advantages  to  be  gained  by  raising  money  by 
means  of  short-dated  securities  (which  at  or  before  ma- 
turity are  to  be  funded,  that  is,  repaid  by  a  loan  raised 
for  a  longer  period,  say  30  to  50  years)  were  soon  so 
evident  that  during  the  past  decade  many  concerns 
adopted  this  plan.  It  has  become  quite  usual,  lately, 
during  the  periods  of  dear  money,  to  witness  the  issue  of 
large  blocks  of  such  securities.  These  issues  are  usually 
made  by  governments,  municipalities,  railways  and  in- 
dustrial corporations,  and  occasionally  by  other  enter- 
prises. The  attitude  of  the  market  towards  them  is 
greatly  influenced  by  the  position  of  money,  European 
politics  and  the  volume  of  business  of  this  character 
which  is  being  oifered,  and  last,  but  not  least,  by  the 
character  and  standing  of  the  borrower. 

Writing  in  The  Monetary  Times  Annual  Review, 
Canada,  Mr.  H.  V.  F.  Jones,  a  Canadian  banker  in 
London,  said: 

It  is  not  wise  to  leave  out  of  consideration  the  following 
important  factor  which  will  govern  to  a  large  extent  the  con- 
ditions under  which  the  funding  operation  of  such  short  loans 
is  carried  through.  The  London  market  generally  becomes 
quickly  cognizant  of  any  plethora  of  securities  of  this  descrip- 
tion, and  this  knowledge  tends  naturally  to  react  upon  the 
price,  not  only  of  the  securities  of  the  government  or  corpora- 
tion already  issued  and  dealt  in  on  the  stock  exchange,  but  on 
the  price  at  which  the  new  issue  is  to  be  meule.  Prices  will  tend 
to  fall  and  in  the  long  run  the  borrower  may  have  to  bear  the 
chagrin  of  discovering  that  all  his  manoeuvres  to  avoid  a  period 
of  apparent  dear  money  and  depreciated  prices,  had  ended  in 
failure  and  possibly  severe  loss. 


SHORT-TIME  LOANS  1*1 

'  ,  Canadian  railway  loans.— It  will  be  of  interest 
to  examine  an  issue  in  London  in  August,  1913,  of 
£1,500,000  (part  of  a  total  authorized  issue  of  £2,000,- 
ooii)  five  per  cent,  five-year  secured  notes  of  the  Cana- 
dian Northern  Railway  Company.  The  issue  was  over- 
subscribed by  the  investing  public. 

The  prospectus  states  that  interest  is  payable  halt- 
vearly  and  that  the  notes  are  to  be  in  denominations  of 
£1,000,  £500  and  £100,  and  carry  a  coupon  for  a  full 
half-year's  interest  due  on  February  12,  1914.  They 
■ire  sicured  by  the  deposit  with  Lloyds  Bank,  Limited, 
as  trustees  under  a  deed  of  trust  of  the  following  securi- 
ties: .  , 
.     ,                                                                                        Annual 

^°"""t  Income. 

Amount. 
£450,000     Canadian  Northern  Railway  Company 
4  per  cent  debenture  stock,  due  25th 
February,   1939,   guaranteed  uncon- 
ditionally, principal  and  interest,  by 

the  Province  of  Alberta £18,000 

£500,000  Canadian  Northern  Railway  Company 
4  per  cent  debenture  stock,  due  23d 
January,  1939,  guaranteed  uncon- 
ditionally, principal  and  interest,  by 

the  Province  of  Saskatchewan £20,000 

£300,000  Canadian  Northern  Railway  Company 
4  per  cent  debenture  stock,  due  30th 
June,  1930,  guaranteed  uncondi- 
tionally, principal   and  interest,  by 

the  Province  of  Manitoba £12,000 

£550,000  Canadian  Northern  Pacific  Railway 
Company  4  per  cent  debenture  stock, 
due  2d  April,  1950,  guaranteed  un- 
conditionalK ,  principal  anc  interest, 
by  the  Province  of  British  Columbia  £22,000 
£750,000  Canadian  Northern  Railway  Company 
4  per  cent  perpetual  consolidated 
debenture  stock ■■     i^W.OOO 

£2,550,000  «<'2'««« 


142  CORPORATION  FINANCE 

The  amount  required  annually  to  meet  the  interest 
on  the  total  authorized  issue  of  the  notes  is  £100,000. 

The  Canadian  Northern  Railway  Company  reserved 
the  right  to  redeem  the  notes  at  101  and  accrued  interest, 
either  as  a  whole  or  in  amounts  of  not  less  than  £100,- 
000,  by  drawings  on  any  interest  date  on  60  days'  pre- 
vious notice;  and  in  the  event  of  any  notes  being  re- 
deemed before  the  date  of  maturity,  the  trust  deed  will 
provide  that  the  trustees  shall  release  proportional.^ 
amounts  of  the  government  guaranteed  stocks  and  of 
the  perpetual  consolidated  debenture  stock  respectively. 

Immediately  prior  to  this  issue  in  London,  a  similar 
issue  was  made  by  the  company  in  the  United  States. 
Two  issues  of  short-term  loans  of  the  Grand  Trunk  Rail- 
way were  also  made  about  the  same  time. 

The  railway  executives,  in  adopting  this  form  of  cor- 
poration financing,  had,  as  usual,  to  satisfy  the  thirst  of 
the  invest(  for  information.  This  is  tiie  information 
which  Sir  William  MacKenzie,  president  of  the  Cana- 
dian Northern  Railway  Company,  conveyed  in  a  let- 
ter to  Lloyds  Bank,  Limited  (the  house  responsible  for 
the  issue),  and  which  was  printed  in  the  prospectus: 

The  Canadian  Northern  Railway  Company  is  at  present 
operating  4,620  miles,  which  includes  6+4  miles  of  leased  lines. 
In  addition,  about  408  miles  of  track  has  Wn  laid  on  new 
branch  lines  and  will  shortly  be  opened  for  traffic,  and  about 
300  miles  more  are  under  construction. 

The  net  earning  of  the  company  have  been  steadily  pro- 
gressive, as  the  following  figures  show: 

Year  ending  30th  June,  1908 $3,032,687 

••  **  1909 3,506,362 

**  **  1910 4,844,890 

*  ••  1911 4,990,347 

••  *  1912 5,881,043 


SHORT-TIME  LOANS 


143 


The  net  earnings  for  the  year  ending  30th  June,  1913, 
are  computed,  subject  to  final  audit,  to  have  amounted  to 
$7,050,000. 

The  available  net  earnings  exceeded  the  amount  required  to 
nay  the  interest  on  the  4  per  cent  perpetual  consolidated 
(itbcnture  stock  for  the  year  1909-10  by  $1,030,757;  1910-11 
by  $1,007,695;  1911-12  by  $1,250,200,  and  it  is  computed, 
subject  to  final  audit,  that  there  will  be  an  available  surplus 
for  the  year  1912-13  of  $1,600,000. 

At  June  30th,  1912,  the  company  had  accumulated  sur- 
pIiHcs  to  the  credit  of  profit  and  loss  account: 

On  account  of  land  saies $16,874,826 

On  account  of  railway  operation  . .     5,986,553 

.$22,861,379 

74.  Three-year  land  notes. — Another  form  of  short- 
term  financing  was  a  Canadian  ottering  made  in  the 
London  market  in  1918  in  the  shape  of  an  issue  of 
$2,300,000  six  per  cent,  three-year  notes  of  the  Terminal 
Cities  of  Canada,  Limited.  The  price  was  97.  The 
notes  were  secured  upon  lands  with  an  estimated  value 
of  $5,250,000.  The  company  undertook  to  pay  to  the 
trustees  the  net  proceeds  of  all  land  sales  and  the  interest 
on  unpaid  instalments  of  purchase  price,  and  not  to  par- 
ticipate in  the  proceeds  of  the  sale  of  lands  or  otherwise 
secure  any  profit  until  the  notes  had  been  redeemed  in 

full. 

Canadian  bankers  are  watching  closely  the  develop- 
ment of  short-term  corporation  financing  and  may  not 
be  expected  to  encourage  it  greatly  in  Canada.  They 
nre  mindful  of  the  fact  that  the  displacement  of  short- 
term  notes  by  long-date  securities  can  be  done  only  out 
of  the  money  which  investors  have  saved.  When  bankers 
commenced  to  think  seriously  of  this  matter  they  reman- 


144 


CORPORATION  FINANCE 


mi 


I. 


bered  the  fear  of  London  authorities  that  the  accumu- 
lation of  savings  would  not  be  on  a  scale  large  enou^li 
to  take  care  of  issues  of  securities  which  were  being  de- 
ferred for  the  time  being  by  short-date  financing  on  the 
basis  of  between  five  and  six  per  cent. 

75.  Problems  of  short-term  loans. — In  an  interview 
in  The  Financial  Post  of  Canada,  Sir  Edmund  Walker, 
Toronto,  said  that  it  would  take  more  to  fund  the  short- 
date  notes  than  it  would  to  rehabilitate  the  Balkan  States 
after  the  devastation  of  the  war  of  1912-13.  !Most  of 
these  notes  had  been  issued  on  a  comparatively  high 
rate  accepted  temporarily  in  the  hope  that  conditions 
would  change  so  as  to  permit  of  their  d  >?  lacement  by 
long-term  securities  bearing  a  lower  rate  of  interest.  Ca- 
nadian borrowers  had  shared  in  this  class  of  financing, 
but  by  far  the  greatest  proportion  had  been  done  by 
the  United  States  railroads.  It  was  feared,  said  Sir 
Edmund,  that  it  would  be  some  time  before  the  market 
would  be  in  a  position  to  absorb,  on  a  long-term  basis, 
the  huge  accumulation  which  had  taken  place  during  the 
year. 

Besides  the  scarcity  of  money  saved  by  investors, 
there  was  another  difficulty  in  the  shape  of  the  nature  of 
the  security  back  of  the  loans.  There  are  some  misgiv- 
ings in  the  mind  of  the  financial  world  of  London  as  to 
the  quality  of  the  security. 

Discussing  the  problems  of  short-term  loans,  a  con- 
tributor in  The  Financier  and  liulUonist,  London,  said 
that  while  the  Canadian  Northern  Railway  Company 
might  be  congratulated  on  the  success  of  its  issue  of 
five  per  cent,  five-year  notes  (referred  to  previously), 
the  episode  was  decidedly  significant  of  the  monetary 
situation  and  the  prospects  with  regard  to  future  issues 
on  somewhat  the  same  lines.    It  was  not  impossible 


SHORT-TIME  LOANS 


145 


tliat  the  decision  of  the  Canadian  Xorthem  management 
to  adopt  this  means  of  raising  further  capital  may  have 
been  influenced  by  the  example  of  a  great  number  of 
railway  and  other  undertakings  in  Great  Britain  and  in 
the  United  States.    The  writer  continues: 

There  is  much  virtue  in  the  redemption  of  securities  within 
a  moderate  period  and  at  a  definite  dat«,  but,  of  course,  short- 
term  notes,  as  usually  understood,  are  on  quite  a  different 
plane.    The  device  has  to  be  regarded  as  appropriate  for  con- 
ditions which,  though  not  altogether  abnormal,  may  be  said  to 
bo  unfavorable  for  the  flotation  of  an  ordinary  issue.    Indeed, 
the  principal,  if  not  the  only  reason,  for  any  commercial  under- 
taking resorting  to  this  form  of  finance,  is  that  capitalization 
by  means  of  permanent  obligation  is  impracticable  or  impos- 
sible.   The  borrower  offers  short-term  bonds,  either  because  he 
cannot  get  money  at  a  profitable  rate  otherwise,  or  because  he 
thinks  that  at  the  end  of  the  term  he  would  be  likely  to  procure 
capital  on  a  permanent  basis  at  a  lower  rate  of  interest.    Now 
British  railway  conipanics  habitually  issue  short-term  notes  to 
tht  ir  bankers  in  connection  with  dividend  payments  and  other 
obligations,  but  it  would  appear  tolerably  certain  that  any 
British  railway  company  which  proposed  to  adopt  such  a 
d. .  ree  to  enable  it  to,  say,  build  new  stations,  or  provide  other 
betterments  to  its  property,  would  immediately  find  »  difficulty. 
pi  rhaps  a  non  possumus,  in  the  way. 

The  fact  is  that  banks  in  general  are  inclined  to  regard  any 
such  proposal  exactly  as  one  trader  may  regard  a  proposal 
bv  anotlur  who  desires  to  strike  a  bargain.  The  very  fact 
ti.at  a  companv  needing  money  comes  forward  with  a  proposal 
of  this  sort  indicates  that  there  is  a  difficulty  in  raising  money 
on  permanent  stock  issued  in  the  usual  way.  In  other  words, 
tli<.  companv  is  in  a  position  which  has  been  brought  abou»: 
partly,  iHrh"a])s,  by  the  condition  of  the  money  market  and  the 
curse  of  investment,  and  partly  by  some  more  or  less  obvious 
weakness  In  its  own  position.    The  proposal  is  that  the  bank 

O— VI— 10 


146 


CORPORATION   FINANCE 


should  advance  so  much  capital  at  a  lower  rate  than  would 
have  to  be  paid  for  it  if  an  issue  were  ma('e  to  the  public. 

In  the  case  of  a  quite  ephemeral  requirement,  such  as  that 
which  arises  in  connection  with  dividend  distributions,  the  se- 
curity which  can  be  offered  to  the  bank  is  so  perfect  that  low 
terms  are  given  without  demur,  but  when  a  company  wants 
capital  to  enlarge  its  operations,  or  to  tide  it  over  an  awkward 
time,  or  to  use  it,  in  fact,  in  any  fashion  which  involves  ordi- 
nary commercial  risks,  then  the  bank  looks  at  the  whole  affair 
from  an  entirely  different  standpoint.  In  such  a  case  the  bank 
manager  may  be  supposed  to  say :  "\Miy  should  I  advance  you 
this  money  for  three  or  five  y^  ^rs  on  easier  terms  than  would 
satisfy  the  ordinary  investor?  If  I  take  your  notes,  what  am 
I  to  do  with  them?  The  ordinary  investor  would  not  look  at 
them,  and  it  is  highly  probable  I  shall  have  to  either  put  them 
in  the  cellar  for  the  whole  term  or  dispose  of  them  to  other 
financial  liouses,  who  would  expect  to  nmke  something  out  of 
their  compliance.  If  you  want  money  at  this  low  rate  of  inter- 
est I  expect  very  first  class  security.  I  see  no  reason  why  I 
should  part  with  my  commodity  at  less  than  its  proper  market 
value." 

Before  the  adoption  of  short-term  financing'  hy  those 
interested  in  eorpo  rat  ions,  serious  consideration  should 
be  given  to  the  need  and  the  advisability  therefor. 


CHAPTER  IX 


THE  CORPOUATE  MORTGAGE 


76.  What  determines  the  value  of  fixed  assets? — 
Now  we  take  up  the  long-time  oMigations — especially 
mortgages  and  mortgage  bonds — of  corporations.  Evi- 
dently they  must  be  based  on  permanent,  or  fixed  assets, 
and  in  amount  will  correspond  roughly  to  the  value  of 
such  assets. 

Here  we  meet  with  the  difficult  and  important 
(jucstion,  What  determines  the  value  of  fixed  assets? 
Most  people  would  be  inclined  to  say  that  the  cost  of  the 
assets  must  determine  their  value.  A  moment's  reflec- 
tion, however,  shows  this  statement  to  be  untrue. 
Sii[)pose,  for  instance,  that  a  man  has  put  up  a  plant  at 
an  expense  of  .$100,000  for  refining  copper,  and  after- 
wards discovers  that  there  is  no  copper  within  hauling 
distance.  The  plant  would  not  be  worth  the  expense  of 
demolishing  it.  On  the  other  hand,  suppose  that  he 
does  put  his  plant  in  a  rich  copper  country  and  secures 
such  favorable  contracts  with  the  mine  owners  that  he 
makes  profits  of  $100,000  a  year  and  may  expect  to  con- 
tinue such  profits  for  an  indefinite  period.  His  plant, 
in  that  case,  could  be  sold  for  perhaps  a  million  dollars. 
iM-idently  cost  of  construction  would  have  very  little  to 
do  with  the  value  of  sudi  assets. 

The  second  opinion  is  tint  the  value  of  fixed  assets 
i^  determined  by  the  expense  of  duplicating  them.  It 
is  claimed,  for  instance,  that  to  arrive  at  a  fair  valuation 
..f  the  railroad  property  »f  the  United  States,  all  we 

147 


148 


CORPORATION  FINANCE 


need  to  do  is  to  figure  how  much  it  would  cost  to  re- 
produce this  property  under  present  conditions.  The 
illustration  already  used,  however,  would  apply  in 
criticism  of  this  second  opinion  as  well. 

The  third  opinion  is  that  the  value  of  fixed  assets  is 
determined  by  their  earning  power  as  in  the  above 
illustration.  It  takes  no  argument  to  show  that  this  is 
actually  the  case  in  ordinary  business  practice.  If  you 
were  going  to  buy  anything  in  the  nature  of  a  fixed 
asset,  from  a  university  education  to  a  steel  mill,  your 
first  question  as  a  business  man  would  be.  How  much 
will  this  asset  earn  for  me?  Similarly,  an  investor  in 
buying  the  securities  of  a  corporation  will  inquire  as 
to  the  value  of  the  corporation's  fixed  assets,  and  will 
naturally  estimate  their  value  on  the  basis  of  earnings — 
not  the  present  earnings  altogether,  but  probable  future 
earnings  as  well. 

Bear  in  mind  that  this  principle  that  earnings  de- 
termine value  is  applicable  only  to  fixed  assets.  The 
selling  value  of  floating  assets,  such  as  raw  material, 
tools,  finished  goods  on  hand,  is  another  matter.  That 
will  be  determined,  normally,  as  the  science  of  economics 
explains,  by  cost  of  production.  The  difference  arises 
from  the  fact  that  fixed  assets — land,  buildings, 
machinery — are  not  intended  for  sale,  but  for  use. 
They  generally  have  little  or  no  value  except  for  the 
purpose  for  which  they  were  intended;  and  their  value 
for  their  purpose  can  be  determined  only  by  their  earn- 
ing power. 

We  have  already  intimated  without  going  into  details 
that  the  amoimt  of  investors*  securities  which  may  be 
issued  by  any  corporation  depends  both  on  the  value 
of  its  fixed  assets  and  on  the  amount  of  its  income 
available  for  interest  charges.    There  is  no  contradic- 


THE  COnrORATE  MORTGAGE 


149 


tion  between  these  two  considerations.  At  bottom  the 
important  factor  on  which  to  base  bond  issues  of  a  going 
concern  is  the  amount  and  stability  of  income.  We 
bluill  elaborate  and  emphasize  this  point  a  little  later. 

77.  Nature  of  a  mortgage  bond.— The  simplest 
method  and  the  method  most  common  among  small  cor- 
porations of  borrowing  long-time  funds  is  by  direct 
mortgage  on  the  corporation's  real  property.  An 
ordinary  mortgage  conveys  "all  right,  title  and  interest" 
in  a  given  piece  of  property  to  the  mortgagee,  with  the 
proviso  that  the  transfer  is  to  become  null  and  void  in 
case  principal  and  interest  are  paid  as  promised.  Al- 
tliough  the  old  common-law  phrases,  which  would  cause 
the  whole  property  mortgaged  to  pass  to  the  mortgagee 
in  case  of  default,  are  generally  retained  in  the  mort- 
gage indenture,  yet  the  mortgage  is  universally  re- 
garded at  law  as  in  effect  a  lien.  A  simple  corporate 
mortgage  is  in  no  important  respect  different  from  a 
mortgage  by  an  individual  or  firm. 

Where  large  sums  of  money  are  to  be  raised  by  a 
mortgage,  however,  the  procedure  is  not  quite  so  simple. 
In  such  a  case  it  is  customary  to  offer  mortgage  bonds 
in  conven-ent  denominations  to  the  public.  As  the 
property  mortgaged  is  for  all  practical  purposes  in- 
divisible and  as  there  are  a  large  number  of  secured 
bondholders,  it  is  impracticable  to  give  a  separate  mort- 
gage with  each  bond.  It  becomes  necessary,  therefore, 
to  give  the  mortgage  to  some  individual  or  concern, 
acting  as  trustee  for  the  bondholders,  in  which  case  the 
mortgage  indenture  becomes  a  deed  of  trust.  Each 
l)ond  is  a  simple  promise  to  pay,  its  phrasing  being  more 
formal,  however,  than  that  of  a  note.  It  is  executed 
under  corporate  seal  and  contains  a  reference  to  the 
indenture  between  the  corporation  and  the  trustee.    A 


150 


CORPORATION  FINANCE 


I 
I 


study  of  the  sample  mortgage  bond  printed  on  page 
151,  will  serve  better  than  a  long  description  to  show 
the  reader  exactly  what  is  contained  in  a  bond. 

The  varieties  of  mortgage  bonds  will  be  considered 
later.  For  the  present  let  us  take  up  the  terms  of  the 
deed  of  trust  between  the  corporation  and  the  trustee. 

78.  Essential  features  of  a  deed  of  trust. — Experi- 
ence has  demonstrated  the  necessity  of  making  this  deed 
very  exact  and  comprehensive.  The  indenture  of  a 
large  railroad  mortgage  may  contain  as  many  as  50,000 
to  100,000  words.  If  printed  and  bcund  it  woidd  make 
a  good-sized  book.  Of  course,  the  ordinary  industrial 
corporation  would  not  find  so  lengthy  and  involved  a 
description  of  the  property  and  the  terms  of  the  mort- 
gage necessary.  To  the  lay  reader  even  a  comparatively 
simple  indenture  is  apt  to  seem  a  mass  of  cumbersome 
and  more  or  less  nonsensical  legal  phraseology;  but  it 
must  be  borne  in  mind  that  every  such  deed  is  closely 
scanned  by  a  large  number  of  able  and  experienced 
lawyers,  who  will  demand  that  no  possible  loophole  for 
evasion  or  misinterpretation  shall  be  left  open.  The 
rights  and  obligations  of  each  of  the  three  parties  to 
the  agreement,  the  corporation,  the  bondholder  and  the 
trustee,  must  be  fully  and  explicitly  set  forth  and  the 
mortgaged  property  nuist  be  described  so  exactly  that 
no  conflict  with  other  mortgages  or  obligations  can 
possibly  arise.  The  instruments  have  now  come  to 
follow  certain  models  and  are  almost  always  arranged 
about  as  follows: 

First,  of  course,  come  the  date  and  the  names  of  the 
parties  to  the  indenture.  Next  follows  the  preamble, 
in  which  is  a  full  statement  of  the  legal  status  of  the 
corporation,  including  the  state  in  which  it  is  incorpo- 
rated, the  amount  of  its  capital  stock  and  bonds,  the 


THE  CORPORATE  MORTGAGE 


151 


152 


CORPOR ATIOX  FIN  ANCE 


amount  and  kind  of  property  it  ow-ns.  The  preamble 
also  presents  the  authority  given  by  the  stockholders  and 
directors  for  the  bond  issue  and  the  specific  purpose  of 
the  issue,  Then  the  full  texts  of  the  bond,  the  interest 
coupon,  if  it  is  a  coupon  bond,  and  the  trustees'  cer- 
tificate of  validity,  which  should  appear  on  each  bond 
(see  form  on  page  151),  are  given. 

The  granting  clause,  which  transfers  the  property 
to  the  trustee,  and  a  detailed  description  of  the  aiort- 
gaged  property  follow.  The  duties  of  the  trustee,  in- 
cluding the  statement  tnat  the  property  is  granted  only 
in  trust,  and  a  provision  that  the  trustee  shall  certify 
to  the  validity  of  each  bond  are  next  set  fortt.  This 
is  followed  by  the  covenant  of  the  corporatiou  to  pay 
the  interest  and  principal  of  the  bonds  at  the  time 
specified. 

An  important  section  of  the  mortgage  is  that  which 
binds  the  corporation  to  keep  the  property  insured,  pay 
all  taxes,  assessments  and  charges,  and  in  general  to 
preserve  the  property  and  keep  the  lien  valid  Another 
section  retains  for  the  company  complete  control  of  the 
mortgaged  property  and  enjojinent  of  all  the  profits 
unless  and  until  default  is  made  of  principal  or  interest. 

Where  a  corporation  has  subsidiary  companies  it  may 
be  necessary  to  include  a  full  statement  as  :o  the  status 
and  securities  of  each  of  these  companies. 

The  sections  following  deal  with  defaiit  and  fore- 
closures. Exactly  what  constitutes  defajlt  must  be 
definitely  stated.  Usually  a  short  period  of  grace  is 
allowed  after  interest  payments  fall  due  before  the 
trustee  can  take  action.  The  percentage  of  bond- 
holders at  whose  request  the  tnistee  shall  take  active 
steps  is  stated,  usually  20  or  25  per  cent.  The  per- 
centage of  bondholders  who  must  request  foreclosure 


THE  CORPORATE  MORTGAGE 


158 


and  sale  in  order  to  authorize  the  trustee  to  proceed 
to  this  extent  is  also  given;  usually  a  majority  is  re- 
(luired.  The  course  of  action  of  the  trustee  in  case  of 
foreclosure  and  sale  is  prescribed  and  the  proceedings 
in  case  of  receivership  are  set  forth. 

The  responsibilities,  liabilities  and  compensation  of 
the  trustee  are  presented  and  provision  is  made  for  the 
resignation  of  the  trus  ee,  or  his  removal  upon  request 
of  a  majority  of  the  1  ndholders,  and  for  the  appoint- 
ment of  his  successor. 

It  is  customary,  although  seemingly  hardly  necessary, 
to  absolve  the  officers  and  directors  of  the  corporation 
from  any  personal  liability. 

In  long  mortgages  there  is  frequently  a  separate  sec- 
tion in  which  terms  and  phrases  used  in  the  indenture  and 
open  to  possible  misinterpretation  are  exactly  defined. 

At  the  end  appear  the  signatures  and  seals  of  the 
corporation  and  of  the  trustee  through  their  proper 
officers  with  formal  attestation  of  the  seals. 

Frequently  modifications  of  the  original  document 
are  called  for  by  changes  in  the  legal  status  of  the  cor- 
poration or  trustee  or  in  the  corporate  property.  Such 
modifications  may  take  the  form  either  of  a  supple- 
mentary indenture  or  of  a  supplementary  agreement. 
The  latter  is  less  formal  and  usually  relates  to  compara- 
tively unimportant  matters.  Supplementary  indentures 
are  most  common  in  case  of  reorganization.  They  must 
he  authorized  by  stockholders  and  bondholders  as  well 
as  by  the  two  parties  directly  concerned. 

79.  Classification  of  mortgage  deeds  of  trust.— Mort- 
sages  are  conveniently  classified  as  closed,  open-end,  and 
limited  open-end.  A  closed  mortgage  covers  a  limited 
amount  of  bonds  all  issued  at  one  and  the  same  time  and 
absolutely  forbids  any  additional  bonds  secured  by  the 


154 


CORPORATION  FINANCE 


same  mortgage.  The  open-end  mortgage  authorizes  an 
indefinite  amount  of  bonds,  some  of  whieh  are  issued  at 
onee  and  some,  under  certain  restrictions,  in  the  future. 
This  type  has  so  fur  been  restricted  to  railroad  com- 
panies. The  usual  provision  is  that  a  given  amount  of 
additional  bonds  may  be  issued  for  each  additional  mile 
of  track  constructed. 

The  limited  open-end  mortgage,  which  is  the  common 
and  for  almost  all  purposes  the  best  type,  names  a  certain 
maximum  amount  of  l)oii(ls  to  be  based  on  the  mortgage, 
part  of  which  amount  is  issued  at  once.  The  rest  may 
be  sold  under  certain  restrictions  as  to  t'me;  usually  a 
given  amount  may  be  i)ut  out  each  year.  Sometimes 
there  are  further  restrictions,  such  as  a  requirement  for 
the  permission  of  the  syndicate  which  bought  the  first 
installment;  or  the  requirement  that  interest  on  out- 
standing bonds  be  paid  for  a  given  period  before  any 
new  bonds  are  sold. 

The  merits  of  this  limited  open-end  mortgage  over 
either  of  the  other  two  types  are  obvious.  An  abso- 
lutely closed  mortgage  may  make  it  very  difficult  for  a 
v  rporation  to  secure  additional  fimds  with  which  to 
carry  on  construction  that  is  essential  to  its  welfare. 
Possibly  the  corporation's  earnings  may  thereby  be  re- 
stricted so  as  to  invalidate  the  bondholders'  as  well  as 
the  stockholders'  interests.  The  open-end  mortgage,  on 
the  other  hand,  is  too  indefinite.  The  corporation  may 
issue  so  many  bonds  under  the  mortgage  and  may  raise 
its  fixed  charges  to  so  high  a  point  as  to  bring  risk  or 
even  actual  loss  to  the  bondholders.  We  must  not  for- 
get in  dealing  with  mortgages  and  mortgage  bonds  that 
in  principle  the  holders  of  these  instruments  are  sup- 
posed to  be  free  from  even  reasonable  risk. 


CHAPTER  X 

TYPES  OF  CORPORATION  BONDS 

80.  Classification  of  bonds.— This  and  the  following 
c  hapter  are  tievoted  to  enumerating  and  describing  the 
various  types  of  bonds  that  are  in  common  use.  We 
Nsonld  recommend  tliat  they  be  studied  with  particular 
(are;  for  ignorance  as  to  the  exact  nature  and  uses  of 
each  of  the  bond  types  named  may  very  easily  prove 
rostly  both  to  investors  and  to  corporations.  An  error 
;liat  is  particularly  frequent  in  small  manufacturing  cor- 
porations is  to  create  a  bond  issue  of  a  type  that  is  not  at 
,11  adapted  to  the  financial  status  and  prospects  of  the 
corporation.  One  attentive  reading  of  these  two  chap- 
.  rs  would  have  prevented  many  of  these  errors. 
Bonds  may  be  classified  with  respect  to: 

(a)  The  security  for  their  payment, 

(b)  Their  purposes, 

(c)  The  manner  of  their  payment, 

(d)  The  conditions  of  their  redemption. 

As  these  classifications,  which  should  be  kept  quite  dis- 
tinct,  are  frequently  confused,  the  writer  has  made  up 
■lie  following  list  of  the  words  commonly  used  in  de- 
scribing bonds,  each  word  being  placed  under  its  proper 
Leading: 


\. —Security  of  Bonds. 

1.  First  Mortgage, 

2.  Second  Mortgage,  Third  Mortgage,  etc. 

155 


MO 


C'OUPOUATION   FLNAXd; 


3.  Terminal,  Divisional,  I^and-Grant,  or  other  Spe- 

cial Mortgage, 

4.  Gr»t  ral  Mortgage, 

5.  Sii       tg-f'und, 

«.  Co.,    eral  Trust, 

7.  Car  (»'  K(jiiipn»ent  Trust, 

8.  Debenture, 

9.  Income, 

10.  Participating, 

11.  Profit-Sharing, 

12.  Joint, 

13.  Receivers'  Certificates. 


B. — Purposes  of  Bonds. 

1.  Unifying, 

2.  Uefunding, 

3.  Constniction, 

4.  Purchase-]Money, 
.).  Improvement, 

0.  Extension, 

7.  Adjustment, 

8.  Consolidated. 

C. — Manner  of  Payment. 

1.  Coupon, 

2.  Registered, 

3.  Registered  as  to  principal,  hut  dividends  in  <N)u- 

pon  form. 

ly.—Conditions  of  Redemption. 

1.  Gold,     • 

2.  Redeemable, 

3.  Serial, 

4.  Convertible. 


TYPES  OF  CORrORATlON  BONDS  1">T 


81.  Mortgage  bonds.— A  bond  secured  by  a  first 
mortgage  on  all  the  real  property  of  a  corporation- 
provided  the  corporation  is  stable  and  prosperous  and 
tlie  bond  issue  is  not  large— is  regarded  as  a  highly  de- 
sirable investment.  You  could  infer  this  from  the  quo- 
tations on  th;  first  mortgage  bonds  of  the  standard 
railroads  and  industrial  companies,  as  shown  in  the  three 
examples  below.  It  should  be  noted  that  none  of  these 
three  issues  is  secured  by  an  absolute  first  mortgage. 
Such  issues  are  usually  small  and  then  prices  are  hard 
to  determine. 

At  present  prices,  Baltimore  &  Ohio  first  4's  yield 
ahout  4.0.5  per  cent;  Western  Union  first  4's,  about 
U5  per  cent;  and  Union  Pacific  first  4's,  about  4.02 

per  cent. 

A  debt  secured  by  a  bona  fide  first  mortgage  cannot 
be  interfered  with  by  any  inferior  security  and,  unless 
the  corporation  goes  into  receivers'  hands,  no  security 
of  higher  rank  can  be  put  out. 

It  is  always  possible,  of  course,  to  place  a  second  mort- 
jrage  on  the  same  property  covered  by  the  first  mortgage 
atid  to  follow  the  second  mortgage  by  a  third,  and  a 
fourth,  and  so  on.  It  is  very  seldom  possible,  however, 
to  find  buvers  for  an>'thing  junior  to  a  second  mortgage 
l)ond.  Although  bonds  derive  their  value  in  large  part 
from  income,  yet  as  they  are  nominally  based  on 
property,  investors  do  not  like  junior  bonds.  Their 
dislike  is  not  unreasonable,  for  in  case  of  reorganization 
the  heaviest  loss  would  necessarily  fall  on  the  holders 
of  junior  securities.  Many  large  corporations  have 
nmde  every  effort  to  give  each  one  of  their  bond  issues, 
tio  matter  bow  numerous  these  issues  may  be.  the  ap- 
|).arance  of  being  based  on  a  first  mortgage.     To  this 


158 


CORPORATION  FINANCE 


end  many  ingenious  expedients  and  names  have  been 
invented. 

For  instance,  there  are  many  railroad  divisional  and 
terminal  first  mortgage  bonds.  Sometimes  these  bonds 
are  based  on  property  highly  valuable  in  itself.  Some- 
times, however,  they  are  first  mortgages  on  branch  lines 
or  on  terminal  real  estate  that  would  be  of  very  little  use 
to  any  concern  except  the  particular  railroad  that  issues 
the  bonds.  In  such  a  case  the  vaunted  priority  of  the 
divisional  or  terminal  bond  is  more  or  less  of  a  fiction.  A 
railroad  could  give  up  the  branch  line  or  the  terminal 
real  estate  far  more  easily  than  the  bondholders  could 
afford  to  havo  the  property  separated  froui  the  railroad. 

Another  very  conmion  practice  with  both  railroads 
and  industrials  is  t(»  have  first  mortgage  bonds  issued 
by  subsidiary  companies  and  then  have  a  nominal  first 
mortgage  bond  issued  by  tlie  holding  company.  The 
holding  company's  bond  is  in  reality  based  only  on  its 
holdings  of  subsidiary  companies'  securities  and  is  infe- 
rior to  all  the  sid)sidiary  (•(»uij)auy  bonds.  Various  names 
are  given  to  these  junior  issues.  Sometimes  they  are 
called  "first  and  refunding"  mortgage  bonds,  or  "first 
general"  moi  tgage  bonds,  or  "first  and  unifymg."  The 
words  "unifying,"  "consolidated,"  "refunding,"  and  the 
like,  u.sed  in  this  connection,  are  intended  to  signify  that 
the  underlying  bonds  v.  ill  he  retired  as  they  fall  due  with 
the  proteeds  of  tin  lu  «  issue,  ft  would  perhaps  not  be 
jjist  to  say  that  these  nauies  are  intended  to  mislead;  but 
at  least  it  may  be  sai<l  that  they  put  the  most  favorable 
pf)ssiblf  constriu'tion  on  the  terms  under  which  the  bomls 
are  issued. 

H2.  Sinhiiif/  fiintJ  Jtntuh.  In  the  c.isr  of  mines  and 
other  enterprises  wliitji  !  .i\c  i\  pretty  dfiiuitc  lease  of 
life  it  is  necessary  for  t  k'  j)roteetion  of  bondholders  to 


TYPES  OF  CORPORATION  BONDS 


159 


tstal)lisli  a  sinking?  i'uiul  for  the  redemption  of  mortgage 
Ik.ikIs.  In  such  cases  the  sinking  fund  is  frequently 
(ilitained  by  setting  aside  a  certain  portion  of  the  com- 
pany's income.  Lumher  companies  soiiictinies  reserve 
a  certain  amount  on  each  thousand  feet  of  himber  cut 
and  coal  mining  companies  a  certain  amount  on  each 
Um  of  coal  mined.  It  is  more  common,  however,  to  set 
aside  a  fixed  amount  each  year. 

There  are  three  iiicUuhIs  of  estimating  the  amount  that 
slitMild  be  set  aside  each  year.    One  method  is  to  divide 
till  amount  of  the  debt  by  the  number  of  years  that  the 
(kbt  runs  and  put  into  tiic  fund  each  year  the  resulting 
amount.     This  is  simpk'  enough,  but  decidedly  crude. 
A-,  no  account  is  taken  of  interest  on  the  sums  m  the 
tiind,  tlie  metliod  ties  i.p  an  unnecessarily  large  amount 
ill"  money.    The  second  method  allows  whatever  is  put 
into  the  fund  to  accumulate  at  compound  interest  and 
tliriefore  calls  for  a  nnich  smaller  annual  payment  than 
:lic  prece<iing  method.     The  third  method  is  what  is 
!  nr)wn  as  the  installment  or  annuity  method  and  con- 
M>ts  in  paying  eijual  periodic  installments  to  the  bond- 
holders, or  their  trustee,  to  settle  principal  and  interest 
n  a  given  number  of  years.     It  calls  for  somewhat 
1  iger  payments  than  the  second  method,  inasmuch  as  it 
takes  care  not  only  of  the  principal,  but  of  the  interest 
;is  well.    A  fullei  (liseussion  of  sinking  fund  methml  is 
unnecessary,  as  the  sul»ject  has  been  covered  in  the 
volume  on  Aicouxtim;  Pkaitkk. 

Tlie  sinking  fund  method  of  guaranteeing  that  l)ond 
issues  will  be  i)aid  has  \kv\\  much  use«l  by  industrial  cor- 
porations. i)artieularly  when  the  permanence  of  their 
l-usiness   is  somewhat   uncertain    and    investors   conse- 
iientlv  are  incline*!  to  l<M.k  upon  their  securities  with 
iispicion.  In  such  a  case  it  may  be  an  advisable  arrange- 


160 


CORPORATION  FINANCE 


m 


'  i- 


ment  both  for  the  cor[)orati()n  and  for  the  bondholders. 
Where  the  corporation's  assets,  however,  are  of  a  per- 
manent nature,  the  sinking  fund  is  no  hm^^er  regarded 
with  favor.  The  objections  to  its  use  are  clearly  stated 
in  the  followinjjr  selection  from  Professor  E.  S.  Meade's 
"Trust  Finance." 

The  sinking  fund  is  of  no  lunofit  to  the  stockholder  other 
than  to  ultiniutclv  dirreiise  the  liabilities  of  the  company.  Dur 
ing  a  long  ])eri(Kl,  however,  the  corporation  is  under  the  neces- 
.sitv  of  paying  interest,  and  at  the  same  time  of  contributing  to 
the  sinking  fund.  The  result  of  this  double  contribution  is,  for 
perhaps  twenty-five  years,  to  compel  the  stockholder  to  pay 
double  for  the  money  borrowed.  The  amount  available  for  divi- 
dends IS,  therefore,  reduced,  and  the  stockholder  suffers. 

It  may  lie  argued  that  tli  stockholder  will  eventually  receive 
full  compensation  for  thes^-  smaller  dividends  in  the  reduction 
of  fixed  charges  which  the  sinking  fund  will  eventually  brin^' 
about ;  Imt  aside  from  the  fact  that  it  is  a  hardship  for  him  to 
wait  so  h)ng  for  this  reward,  there  is  the  further  objection  that 
oven  after  the  reduction  of  liabilities  by  the  cancellation  of  the 
bond  principal,  the  owners  of  the  company  will  have  made, 
averaging  the  periods  before  and  after  the  retirement  of  the 
bonds,  smaller  profits  than  if  no  sinking  fund  had  been  gath- 
ered. The  reason  for  this  permanent  reduction  of  profits  by 
the  collection  of  a  sinking  fund  is  as  follows:  A  sinking  fund 
must  be  invested  in  v  curities.  It  cannot  be  put  into  bi-tter- 
nients.  In  the  form  in  which  it  is  accumulated,  a  low  rate  of 
interest  from  the  investment  of  these  annual  sums  is  all  that 
can  Ih'  (xpected.  The  comjiounding  of  these  investments,  it  is 
suppose<l,  ecjiials  the  principal  of  the  bonds  at  the  time  of 
maturitv,  an«'  the  corporation  is  tlu-reafter  freed  from  n  por- 
tion of  it>  fixid  chargt^s.  This  gain,  however,  is  in  reality  u 
loss  to  the  ^tockholdirs.  I>  the  money  whi<'h  has  gone  into  the 
sinking  fuiul  had  h. en  sp<nt  upon  Improving  the  property,  the 
stockhoKhrs  Mould  <  vintually  have  received  a   l.irger  dividend. 


TYPES  OF  CORPORATION  BONDS 


161 


It  may  be  assumed  that  the  corporation  can  earn  a  higher 
rifurn  on  money  invested  in  improving  its  own  property  than 
th.  itturii  on  securities  purciiased  for  the  sinking  fund.    Under 
tlu>L  circumstances,  it  is  a  good  policy  to  devote  all  surplus 
tuials  to  increasing  the  earning  power  of  the  company,  allowing 
tin  debt  to  run  without  a  special  provision  for  repayment.    In 
otiiir  words,  by  refunding  bonds  when  they  mature,  and  by  re- 
fu>irig  to  make  uny  deductions  from  profits  to  provide  funds  for 
(l.ht  payment,  a  corporation  not  only  pays  a  larger  dividend  but 
iiK  reases  the  value  of  its  productive  assets  more  rapidly  than  the 
value  of  its  sinking  fund  would  increase  during  an  equal  number 
of  VLurs.  To  put  the  matter  in  still  another  way,  the  accumula- 
tion of  a  sinking  fund  by  a  corporation  decreases  the  propor- 
tion of  debt  to  value  of  property  less  rapidly  than  when  the 
annual  amount  of  the  sinking  fund  is  invested  in  the  equipment.* 

For  the  larger  corporations  the  sinking  fund  is  usually 
in  cliarge  of  a  special  trustee  acting  for  the  bondholders. 
With  smaller  corporations,  however,  it  is  customary  to 
allow  the  sinking  fund  to  remain  in  the  custody  of  the 
corporation. 

«;j.  Collateral  trust  bomh.— With  the  growth  of  large 
JK.lding  companies  a  modified  form  of  mortgage  bond 
lias  come  to  be  widely  used.  It  is  called  a  "collateral 
trust"  bond  because  it  is  based  on  the  securities  of  other 
toiiipanies  owned  by  the  bond-issuing  corporation  and 
deposited  with  a  trustee  as  collateral  security  for  the 
liimdholders.  The  securities  are  covered  by  a  deed  of 
trust  just  as  in  the  case  of  real  property  offered  as 
s«  curity.  The  securities  may  consist  either  of  stocks  or 
of  bonds  of  subsidiary  comi)anies  or  of  a  combination 

of  l>oth. 

It  would  seem  at  first  sight  that  a  collateral  trust  bond 
would  not  be  worth  much,  especially  when  the  collateral 

'TruHt  Fivanrr,  pp.  241-243. 

r— VI— n 


162 


CORPORATION  FINANCE 


consists  of  stock.  In  such  a  case  the  collateral  trust 
bond  would  be  junior  by  several  degrees  to  all  underly- 
ing bonds  of  the  subsidiary  companies.  In  case  any  of 
the  subsidiary  companies  go  into  bankruptcy  and  force 
the  holding  company  to  default,  all  that  the  trustee  for 
the  collateral  trust  bondholders  can  do  is  to  take  the 
stock  posted  as  collateral.  When  he  gets  the  stock  he 
still  is  a  long  distance  from  having  tangible  property 
with  which  to  satisfy  the  demands  of  the  bondholders. 
Even  when  the  collateral  consists  of  bonds  they  are 
usually  junior  issues  and  the  collateral  trust  bondholders 
in  case  of  default  are  very  uncertain  as  to  getting  pos- 
session of  real  property. 

Nevertheless,  collateral  trust  bonds  are  sold  at  high 
prices.  The  Northern  Pacific-Great  Northern  collateral 
trust  4's,  which  are  secured  by  the  deposit  of  Chicago, 
Burlington  &  Quincy  Railroad  Company  stock,  have 
steadily  sold  close  to  par.  :Many  other  similar  issues 
are  well  thought  of  in  the  financial  district.  One  reason 
is  that  the  income,  out  of  which  interest  on  the  collateral 
trust  bonds  is  paid,  is  derived  from  the  interest  and  divi- 
dends on  the  collateral,  and  these  latter  returns  are  more 
regular  than  are  railroad  or  industrial  profits.  A  second 
reason  is  that  securities,  if  they  are  worth  anything  at  all, 
are  almost  always  readily  salable,  whereas  real  property, 
even  if  its  cost  and  value  are  high,  is  apt  to  prove  im- 
marketable.  Hence,  the  collateral  trust  bonds  have 
preat  advantages  in  these  respects  which  in  the  eyes  of 
the  financial  public  often  outweigh  their  obvious  dis- 
advantages. 

Strange  as  it  may  seem,  it  is  not  impossible  for  a  hold- 
ing company  with  subsidiaries,  whose  credit  is  poor,  to 
take  the  stocks  and  bonds  of  these  companies,  post  them 
as  collateral  and  sell  the  collateral  trust  bonds  very 


TYPES  OF  CORPORATION  BONDS 


168 


readily.  It  is  not  unnatural  to  feel  a  passing  doubt  as  to 
the  sanity  of  the  financial  world  when  one  discovers  that 
:i  premise  to  pay  based  on  real  property  is  less  valuable 
than  a  promise  to  pay  based  on  paper  that  is  itself  based 
„n  the  same  real  property.  Yet  after  all  there  is  a  sound 
reason  for  this  apparent  absurdity.  Real  property  is 
hard  to  sell;  paper  representatives  of  property  may  be 
easily  sold.  Collateral  trust  bonds  are  therefore  fre- 
(Hiently  excellent  means  of  raising  funds  for  subsidiary 
lompanies  without  much  credit  of  their  own. 

They  are  also  very  useful  at  times  in  financing  the 
process  of  buying  control  of  subsidiary  companies.  The 
liolding  company  borrows  money  from  the  banks  and 
hiiys  securities;  then  it  issues  collateral  trust  bonds  based 
(.u'tliese  securities  and  with  the  funds  thus  obtained  pays 
„rt'  the  bank  loans.  Thus  it  finds  itself  with  very  little 
expenditure  of  its  own  funds  in  full  control  of  the  com- 
pany whose  stocks  it  has  bought.  Some  companies  have 
repeated  this  simple  process  time  and  time  again.  It  is 
entirely  legitimate,  though  somewhat  risky. 

To  protect  the  bondholders,  collateral  trust  mort- 
fi'd'^es  generally  provide  against  the  issue  of  any  securi- 
ties by  subsidiary  companies  ahead  of  those  deposited  as 
collateral.  The  mortgages  also  frequently  have  clauses 
to  prevent  unfavorable  leases  or  other  misuse  of  prop- 
erty represented  by  the  deposited  securities. 

A  further  study  of  this  type  of  bond  belongs  in  the 
subject  of  investments  rather  than  here.  Enough  has 
heen  said  to  indicate  how  a  holding  company  may,  by 
means  of  collateral  tnist  bonds,  borrow  funds  which  it 
would  probably  be  impossible  for  the  subsidiary  com- 
panies to  reach. 
j  8-4.  Equipment  trust  bonds.— Thh  form  of  bond  is 
extent  by  other  than  railroad  companies. 


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any 


164 


CORPORATION  FINANCE 


The  equipment  used  as  security  for  a  bond  issue  of  this 
kind  does  not  belong  to  the  railroad  company  at  all. 
The  manufacturers  of  the  equipment  usually  turn  it 
over  to  an  intermediary  company,  which  in  turn  leases  it 
to  the  railroad,  generally  for  a  term  of  ten  years  or  less, 
and  hands  over  the  lease  to  the  trustee  of  the  equipment 
trust  bondholders.  The  railroad  pays  to  the  trustee  the 
purchase  price  of  the  equipment  in  equal  installments, 
together  with  interest  on  unpaid  installments.  When 
the  payment  is  complete,  the  lease  is  cancelled  and  the 
title  to  the  equipment  passes  to  the  railroad  company. 

In  the  meantime,  in  order  to  pay  the  manufacturers 
the  intermediary  company  issues  bonds  to  about  80  or  90 
per  cent  of  the  cash  value  of  the  equipment.  The  bonds 
are  in  serial  form  so  that  as  fast  as  purchase  money  is 
received  from  the  railroad  it  may  be  devoted  to  their 
redemption,  and  the  series  is  so  arranged  that  when  the 
last  payment  by  the  railroad  is  made  the  last  bonds  are 
redeemed. 

The  form  of  an  equipment  trust  bond  Is  given  on 
page  187,  and  the  following  extract  from  the  prospec- 
tus of  one  of  the  early  intermediary  companies  in  this 
field  will  further  explain  the  working  of  this  ingenious 
plan. 

The  business  of  the  Railroad  Equipment  Company  is  to  lease 
and  conditionally  sell  on  what  is  known  as  the  Car  Trust  plan, 
to  railroad  and  other  corporations  directly  connected  there- 
with, certain  needed  Rolling  Stock. 

A  cash  j)aymcnt  ranging  from  10  per  cent  to  as  high  even  as 
50  per  cent  is  made  at  the  outset,  and  the  principal  and  interest 
of  the  balance  due,  represented  by  the  promissory  notes  of  the 
Corporation,  maturing  at  fixed  intervals  over  a  term  of  years,  is 
secured  by  a  first  Hen  or  mortgage  on  the  said  Rolling  Stock, 


TYPES  OF  CORPORATION  BONDS 


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the  whole  of  which  remaint  at  tuch  security  untU  the  last  note 
is  paid. 

These  deferred  payments  extend  over  a  period  ranging  from 
four  to  ten  years,  and  during  such  periods  and  until  the  final 
payment  is  made  and  all  the  provisions  of  the  Car  Trust  Con- 
tract have  been  fully  complied  with,  the  conditional  purchaser 
uses  the  Rolling  Stock  as  lessee  only,  and  subject  to  the  legal 
rights  of  the  lessor,  in  whom  the  title  to  the  property  remains 
fixed  and  inalienable  and  unaffected  by  any  liens  or  indebtedness 
of  any  kind  of  the  lessee. 

The  lessee  is  also  bound  by  the  contract  to  keep  the  Rolling 
Stock  in  proper  repair,  to  replace  it  if  destroyed,  and  to  hold  it 
at  all  times  subject  to  the  inspection  (it  being  readily  identified, 
not  only  by  the  road  numbers,  but  by  the  ownership  plates 
invariably  attached  to  each  locomotive  or  car)  of  the  lessor,  by 
whom  and  for  whose  benefit  it  is  fully  insured. 

In  case  of  default  of  any  of  the  payments,  or  of  non- 
performance of  the  other  provisions  of  the  contract,  the  lessor 
has  the  legal  right,  not  only  fully  recognized  and  confirmed  by 
the  United  States  Courts,  but  also  protected  by  direct  legisla- 
tion in  many  of  the  States,  to  take  inunediate  possession  of  the 
Rolling  Stock  wherever  it  may  be,  or  however  in  use,  to  i -11  it  at 
public  or  private  sale,  and  to  apply  the  proceeds  to  the  payment 
of  any  indebtedness  arising  under  the  contract,  whether  matured 
or  not,  and  in  cases  where  a  Receiver  is  appointed,  the  rule  of 
the  Courts  is  to  order  him  to  pay  the  Car  Trust  notes  as  they 
mature,  rather  than  lose  the  use  of  the  Rolling  Stock  and  the 
benefit  of  the  payment  already  made  on  it. 

The  securities  arising  under  these  Car  Trusts  are  assigned 
to  a  Trust  Company,  and  are  held  by  it  in  trust,  as  security  for 
certain  Bonds  of  The  Railroad  Equipment  Company  issued 
against  the  same. 

The  holder  of  these  Bonds  has  therefore  as  his  security: 

The  direct  obligation  of  the  Railroad  Equipment  Company. 

The  direct  obligations  maturing  at  specified  dates,  generally 
monthly  or  quarterly,  of  the  Corporation,  the  lessee  of  the 
Rolling  Stock. 


^5JSScf 


TYPES  OF  CORPORATION  BONDS 


167 


The  absolute  ownership  of  such  Rolling  Stock  which  is  kept 
in  repair,  insured,  and  replaced  if  destroyed,  and  the  first  cost 
of  nhich,  already  reduced  by  th?  cash  payment  at  the  outset,  is 
being  steadily  still  further  reduced  by  the  periodical  payment 
niude  by  the  lessee. 

The  security  behind  bonds  of  this  character  is  excel- 
lent. In  the  first  place,  no  railroad  has  ever  yet  de- 
faulted on  an  equipment  trust  bond  issue,  because  to  do 
so  would  mean  a  loss  of  its  equipment.  All  through  the 
railroad  receiverships  of  the  90's  the  receivers  paid  the 
interest  and  principal  on  these  bonds  regularly.  In  the 
second  place,  the  railroad  merely  leases  the  equipment 
until  the  last  payment  is  made  and  in  case  of  default, 
therefore,  no  legal  process  is  necessary  in  order  to  enable 
the  trustee  to  take  physical  possession  of  the  property. 
The  leases  usually  provide  that  the  equipment  is  to  be 
kept  in  good  repair. 

In  effect  this  form  of  security  is  a  kind  of  chattel 
mortgage.  From  the  railroad  corporation  standpoint 
it  is  open  to  the  usual  objection  against  chattel  mort- 
gages, namely,  that  it  pledges  a  semi-fixed  asset  under 
a  short  term  obligation  which  must  be  met  at  all  hazards. 
It  may  well  happen  that  the  railroad,  in  order  to  meet 
this  obligation,  will  have  to  part  with  funds  necessary  in 
order  to  meet  other  fixed  charges.  The  best  managed 
railroad  corporations  use  these  instruments  with  great 
caution.  One  reason  for  their  existence  is  that  many 
existing  first  and  second  mortgages  on  railroad  prop- 
erty have  what  is  called  an  "after-acquired  property" 
clause,  which  makes  the  mortgage  extend  over  all  the 
property  that  the  railroad  owns  at  the  time  of  making 
the  mortgage  and  all  that  it  acquires  thereafter.  Under 
this  clause  a  straight  mortgage  on  equipment  would  not 


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CORPORATION  FINANCE 


be  a  first  lien.    The  lease  is  the  method  by  which  this 
difficulty  is  overcome. 

The  market  for  equipment  trust  bonds  is  narrow, 
partly  because  the  public  does  i-ot  thoroughly  under- 
stand them  and  partly  because  Ine  issues  are  relatively 
small.  They  are  largely  bought  by  banks,  insurance 
companies  and  other  financial  institutions  desiring  to 
invest  their  reserve  funds  to  the  best  advantage.  The 
average  yield  on  equipment  trust  bonds  is  considerably 
better  than  on  ordinary  mortgage  bonds  and  their  safety 
is  almost  perfect. 

The  principle  of  the  equipment  trust  bonds  is  not 
applied  to  any  considerable  extent  in  industrial  corpo- 
rations and  with  very  few  exceptions  it  would  be  highly 
inadvisable  for  such  corporations  to  buy  equipment  in 
this  manner. 

85.  Five-year  equipment  notes  for  Canadian  rati- 
ways.—Some  surprise  was  created  in  American  and 
English  financial  circles  in  July,  1913,  by  the  issue  in 
London,  by  the  Grand  Trunk  Railway  of  Canada,  of 
£1,500,000  five  year,  five  per  cent  secured  notes,  dated 
October  1,  1913,  and  due  October  1,  1918.  The  notes 
were  to  be  in  denominations  of  £200  and  £100,  and  could 
be  registered  as  to  principal  only.  The  company  re- 
served the  right  to  redeem  the  notes  at  101  either  as  a 
whole,  or  in  amounts  of  not  less  than  £200,000  by  draw- 
ings on  any  interest  date  upon  sixty  days'  notice;  and 
in  the  event  of  any  notes  being  redeemed  before  the  date 
of  maturity  the  trustee  would  release  a  proportionate 
part  of  the  debenture  stock  deposited  with  them  as  secur- 
ity. The  notes  were  secured  by  the  deposit  with  the 
trustee  of  £2,000,000  Grand  Trunk  perpetual  four  per 
cent  consolidated  debenture  stock.  The  issue  price  was 
98,  payable  as  follows: 


TYPES  OF  CORPORATION  BONDS 


169 


Per  Cent 

£5 

£30 

£30 

£33 


On 

Application 

Allotment 

August  30th,  1913 

September  30th,  1913 


£98 


According  to  a  statement  in  the  prospectus  by  Mr.  A. 
W.  Smithers,  chairman  of  the  Grand  Trunk  directorate, 
the  proceeds  of  the  notes  were  to  be  "applied  in  part  pay- 
ment for  additional  rolling-stock  (75  engines  and  8,000 
freight  cars),  the  contract  price  for  which  exceeds  £2,- 
000,000.  This  new  equipment  has  become  necessary 
owing  to  the  approaching  completion  of  the  Grand 
Trunk  Pacific  Railway  and  to  the  very  large  increase 
in  the  traffic  of  the  system — including  the  Grand  Trunk 
Western,  Detroit,  Grand  Haven  and  Milwaukee,  and 
Canada  and  Atlantic  Railways,  but  not  including  the 
(irand  Trunk  Pacific  Railway." 

It  therefore  looked  like  an  issue  of  equipment  notes, 
hut  Canadian  financial  authorities  have  not  been  inclined 
to  class  them  as  such,  as  the  terms  of  payment  and  the 
periods  are  different  from  the  standard  equipment  trust 
hond  or  note  described  in  previous  pages.  About  the 
same  time  the  Grand  Trunk  Railway  sold  an  issue  of 
(•(|nipment  notes  in  the  United  States.  The  five-year 
note  issue  in  London  must  be  considered  as  an  ordinary 
short-term  loan,  and  as  such  it  created  a  considerable 
flutter  in  financial  circles.  One  objection  raised  in  Lon- 
don to  borrowing  on  such  onerous  terms  was  that  it 
tended  to  depreciate  the  value  of  the  company's  deben- 
ture stocks. 

The  company  did  get  the  money,  as  the  issue  was  over- 
subscribed. 


170 


CORPORATION  FINANCE 


,1 


A  cable  message  from  London  stated  that  the  market 
there  objected  to  the  company  embarking  on  a  new  form 
of  financing  by  the  issue  of  short-term  notes,  but  that  it 
was  being  pointed  out  that  many  of  the  first-class  roads 
in  the  United  States,  such  as  the  Lake  Shore  and  the 
New  York  Central,  had  been  recently  doing  the  same 
thing  and  on  no  better  terms  than  the  Grand  Trunk 
was  able  to  obtain;  in  fact,  in  most  cases  the  United 
States  lines  had  to  pay  considerably  higher  rates  than 
the  Grand  Trunk  for  temporary  loans  of  this  nature. 

The  short  life  of  such  securities  as  these  Grand  Trunk 
notes  recommends  them  specially  to  a  growing  class  of 
investor  which  confines  itself  to  redeemable  securities 
of  this  kind.  It  brings  us,  however,  to  the  question  of 
short-term  loans  generally,  which  is  discussed  elsewhere. 


I* 


CHAPTER  XI 

TYPES  OF  CORPORATION  BONDS  (CONTINUED) 

86.  Debenture  bonds. — There  are  two  different  uses 
(if  the  word  debenture  which  are  somewhat  confusing. 
In  law  any  instrument  which  formally  acknowledges  a 
debt  and  promises  payment,  including  any  written  bond  X 
secured  or  unsecured,  is  a  debenture.  In  finance,  how- 
ever, the  term  has  come  to  be  restricted  to  a  bond  which 
is  not  secured  by  a  lien  upon  any  specific  property.  In 
other  words,  it  is  for  all  practical  purposes,  simply  an 
unsecured  promissory  note  running  for  a  number  of 
years.  Being  unsecured,  the  debenture  bond,  in  case 
of  insolvency,  is  legally  on  the  same  level  as  the  general 
floating  indebtedness  of  the  insolvent  corporation. 

The  debenture  is  much  used  in  the  financing  of  Eng- 
lish corporations.  Indeed,  our  American  mortgage 
bond,  in  the  case  of  railroads  at  least,  is  there  almost 
imknown.  It  is  used  so  largely  because  the  English 
investors  realize  clearly  that  the  earnings  of  the  railroad 
after  all  are  their  actual  security.  As  has  already  been 
pointed  out,  the  holders  of  a  railroad  mortgage  in  case 
of  foreclosure  seldom  take  the  physical  property  which 
legally  belongs  to  them,  because  to  separate  any  portion 
of  a  railroad's  property  from  the  rest  is  to  diminish  and 
])erhaps  destroy  its  value.  Logically,  therefore,  the 
English  custom  is  right  and  the  American  custom  is 
wrong.  In  practice,  however,  it  is  probable  that  the 
-(\merican  railroad  managers  have  borrowed  more  funds 
on  better  terms  than  have  the  English  railroad  mana- 
gers.   An  English  railroad  corporation  has  only  one 

171 


1    ■ 


172 


CORPORATION  FINANCE 


I 


ILl 


kind  of  bond — the  simple  debenture — to  offer;  an 
American  railroad  corporation  may  offer,  as  we  have 
seen,  an  indefinite  variety  of  mortgage  bonds,  each  bond 
being  secured  by  a  lien  on  some  part  or  section  of  the 
railroad  property.  The  American  junior  bond,  for  that 
reason,  looks  better  to  the  average  investor  than  the 
English  junior  bond,  and  is  more  readily  salable.  Notice 
that  this  statement  says  "looks  better,"  not  "is  better." 
If  all  American  railroad  mortgage  bonds  were  to  be 
exchanged  for  simple  debentures  arranged  in  the  order 
of  their  priority,  investors  would  be  as  well  off  as  they 
are  now. 

Under  the  present  system,  however,  the  existing 
debenture  bonds  are  for  the  most  part  far  inferior  in 
security  and  investment  standing  to  mortgage  bonds. 
Indeed,  it  would  hardly  be  correct  to  call  any  of  the 
present  railroad  debenture  bonds,  with  a  few  notable 
exceptions,  investments  at  all  in  the  technical  sense  of 
that  word,  as  previously  defined. 

If  debenture  bonds  are  so  far  inferior  to  mortgage 
bonds  and  therefore  so  much  less  attractive  to  investors, 
why  issue  them  at  all?  There  are  several  possible 
reasons.  In  the  first  place,  a  company  may  have  reached 
its  limit,  so  far  as  mortgage  borrowings  are  concerned; 
it  may  have  nothing  of  any  great  value  left  on  which 
first  and  second  mortgages  have  not  already  been  placed. 
Third  mortgages  are  so  unpopular  with  investors  that  a 
simple  debenture  may  be  more  easily  sold. 

Sometimes  debenture  bonds  are  created  when  a  bank- 
rupt railroad  company  is  reorganized.  The  reorgan- 
izers  may  desire  to  lighten  the  load  of  mortgages  that 
previously  weighed  down  the  company  and  perhaps 
caused  its  bankruptcy.    In  the  general  scaling  down  of 


TYPES  OF  CORPORATION  BONDS 


178 


sitler  in  detail  when  we  take  up  reorganization — the 
junior  mortgage  issues  are  often  replaced  by  debentures. 
This  is  the  origin  of  most  of  our  present  railroad  de- 
bentures. 

A  third  possible  reason  may  be  that  a  conservative 
corporation  is  anxious  to  reserve  some  of  its  resources 
for  future  mortgage  issues.  Suppose  a  railroad,  for 
instance,  already  has  a  first  mortgage  on  all  its  property 
and  desires  to  borrow  a  comparatively  small  additional 
Slim.  If  it  places  a  second  mortgage  on  its  property  it 
Mill  have  used  up  much  of  its  remaining  borrowing 
capacity.  If  it  issues  simple  debentures,  however,  it  will 
still  have  a  second  mortgage  to  fall  back  upon.  Usually 
debenture  bonds  issued  under  such  circumstances  arc 
accompanied  by  an  agreement  between  the  corporation 
and  the  bondholders  to  the  effect  that  if  any  new  issue 
ofmortgage  bonds  is  subsequently  put  out,  the  debenture 
bondholders  shall  be  secured  by  the  same  mortgage  as 
the  new  bondholders. 

A  fourth  reason  that  has  at  times  led  to  the  issue  of 
debenture  bonds  is  that  they  are  intended  to  be  sold  to 
European  investors,  among  whom,  as  has  already  been 
stated,  such  bonds  are  highly  regarded.  In  the  reor- 
^mnization  of  the  Wabash  Railroad  Company  in  1887, 
for  instance,  certain  issues  which  are  actually  secured  as 
to  principal  by  a  third  mortgage  were  nevertheless  given 
tlie  name  of  "debenture  bonds,  Series  A,"  because  they 
were  intended  for  English  investors. 

In  this  country  the  most  successful  railroad  debenture 
bond  issues  are  those  of  the  New  England  railroads,  for 
the  obvious  reason  that  the  earnings  of  these  roads  are 
not  only  large,  but  particularly  stable.  The  Boston  and 
Maine  R.  R.  Co.  has  outstanding  four  mortgage  bond 
issues  and  seven  debenture  issues.     All  of  the  de- 


174 


CORPORATION  FINANCE 


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benture  bond  issues  commanded  good  prices  and  were 
considered  sound  investments.  The  earnings  of  this 
company  have  averaged  six  or  seven  times  interest 
charges.  Similarly  the  New  York,  New  Haven  and 
Hartford  R.  R.  Co.  has  six  issues  of  debenture  bonds 
outstanding  in  addition  to  numerous  issues  of  mortgage 
bonds  of  subsidiary  companies.  The  net  earnings  of 
this  company  have  been  more  than  three  and  one-half 
times  the  interest  charges.  The  practice  of  issuing 
debenture  bonds  seems  to  be  gradually  gaining  favor 
among  American  railroads,  and  a  number  of  lines  have 
adopted  the  policy  of  replacing  mortgage  issues  when 
they  mature  by  simple  debenture  issues.  The  debenture 
bond  is  not  much  used  by  industrial  corporations,  how- 
ever. These  corporations  do  not  usually  have  the  con- 
fidence of  investors  and  the  stability  of  earning  power 
which  are  necessary  to  make  debenture  bond  issues 
successful. 

87.  Income  bonds. — The  income  bond  is  a  hybrid, 
partaking  of  the  nature  of  both  bonds  and  stock.  As 
the  name  implies,  the  payment  of  interest  charges  can 
be  demanded  only  %vhen  there  is  sufficient  income  for 
that  purpose ;  if  the  interest  charges  are  not  earned  they 
need  not  be  paid.  The  principal,  however,  is  usually 
secured  by  a  mortgage.  If  there  is  no  such  mortgage, 
as  happens  in  one  or  two  cases,  the  word  bond  is  a  mis- 
nomer. For  all  practical  purposes  such  an  "income 
bond,"  so-called,  is  preferred  stock  without  voting  power. 

Income  bonds  are  usually  the  product  of  reorganiza- 
tion and  are  designed  to  take  the  place  of  junior  mort- 
gage bond  issues  which  it  is  thought  necessary  to  scale. 
Their  advantage  lies  in  the  fact  that  they  do  not  impose 
any  fixed  interest  charges  on  the  corporation.  How- 
ever, there  is  a  great  disadvantage  in  the  fact  that  the 


TYPES  OF  CORPORATION  BONDS 


175 


principal  is  secured  by  mortgage  and  that  therefore  new 
mortgage  bond  issues  in  the  future  are  hard  to  float. 
Another  disadvantage  is  that  there  is  apt  to  be  dispute 
between  the  corporation  and  the  bondholders  as  to 
whether  the  interest  charges  are  actually  earned  or  not. 
This  objection  can  be  obviated  in  part  by  inserting  in  the 
bond  such  a  detailed  statement  of  the  method  by  which 
net  income  is  to  be  determined  as  is  given  in  the  sample 
income  bond  shown  on  pages  lie  and  l47.  The  new 
system  of  railroad  accounting  under  the  Interstate  Com- 
merce Commission  will  probably  aid  in  the  settlement  of 
this  question  in  connection  with  railroad  companies. 
For  an  example  of  the  difficulties  inherent  in  income 
i)()nds  see  the  case  of  the  Central  of  Georgia  Railway 
Company  cited  in  Chapter  XXVII. 

88.  Other  types  of  bonds.— The  name  of  "participat- 
ing bonds,"  is  almost  self-explanatory.  A  bond  of  this 
class  usually  gets  a  fixed  rate  of  interest  and  in  addition 
a  share  of  whatever  profits  are  earned  by  its  underlying 
security.  The  best  known  issue  of  this  kind  was  the 
Oregon  Short  Line  participating  4's  issued  in  1903  and 
retired  the  next  year,  which  were  secured  by  all  the  stock 
of  the  Northern  Securities  Company,  amounting  to  $82,- 
491,000  in  the  Oregon  Short  Line  treasury.  These 
b(inds  were  to  receive  not  only  the  regular  4  per  cent 
but  whatever  dividends  over  4  per  cent  were  declared 
on  the  collateral  stock. 

Profit-sharing  bonds,  which  are  infrequently  issued, 
usually  entitle  the  bondholder  to  get  back  his  principal 
with  the  agreed  interest  and  also  to  share  in  whatever 
increase  in  the  value  of  the  underlying  assets  may  take 
place  before  the  retirement  of  the  bonds. 

Joint  bonds  are  direct  obligations  of  two  or  more  cor- 


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TYPES  OF  CORPORATION  BONDS 


179 


ponitions  wliich  join  in  issuing  them.  A  wellkn;  -- 
example  is  the  Northern  Pucilie-Grenc  Northern  issue  of 
joint  eollateral  trust  4'9.  Somewhat  the  same  effect  is 
••aintd  when  a  holding  company  guarantees  a  suhsidiary 
company  bond  issue. 

A  corporate  security  which  should  be  mentioned  here, 
aliliouf^h  it  is  not,  strictly  speaking,  a  bond,  is  a  receivers' 
aititicate.  This  rejirosents  money  expen<led  by  the  re- 
ceivers of  an  insolvent  corporation  under  authority  of 
the  court,  as  shown  in  the  sample  given  on  page  148. 
They  constitute  a  claim  on  the  property  of  the  corpora- 
tion superior  to  all  other  claims  whatever.  They  go 
ahead  of  the  first  mortgage  bonds.  They  do  not,  of 
course,  usually  exist  in  large  quantities  and  a  reorgan- 
ized corporation  will  endeavor  to  refund  and  pay  them 
iff  as  quickly  as  possible.  It  is  mcII  to  bear  in  mind, 
Iiowt'ver,  that  in  the  case  of  an  insolvent  corporation  this 
\iii(l  of  security  may  be  used  as  a  last  resort  when 
funds  t  uld  hardly  be  secured  in  any  other  manner. 

89.  Purposes,  manner  of  payment,  and  conditions  of 
redemption  of  bonds. — The  descriptive  words  applied 
to  bonds  indicating  their  purposes  are  almost  all  self- 
explanatory.  "Unifying,"  "refunding,"  "adjustment" 
and  "consolidated"  imply  that  the  previous  bond  issues 
are  to  be  retired  or  rearranged  in  some  way.  "Con- 
struction," "improvement"  and  "extension"  show  that 
the  funds  secured  from  the  bond  issue  are  to  be  expended 
in  some  kind  of  development.  "Purchase-money"  bonds 
are  sold  before  the  property  on  which  they  are  based  is 
aetually  bought.  Usually  the  funds  secured  by  the  sale 
of  the  bonds  are  turned  over  to  a  trustee  to  be  held  until 
certain  specific  property  is  purchased.  Then  the  funds 
irr  ])aid  out  by  the  trustee  and  he  receives  in  return  a 
ilist  mortgage  on  the  property. 


180 


CORPORATION  FINANCE 


J 

III 


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A  registered  bond  is  issued  to  an  individual  in  the 
same  manner  as  a  certificate  of  stock  and  ownership  can 
be  transferred  only  on  the  books  of  the  company. 
Interest  is  paid  by  checks  which  are  sent  out  to  the 
registered  owner.  Coupon  bonds  are  usually  payable 
to  bearer  and  interest  payments  are  represented  by 
coupons  attached  to  the  bond,  as  indicated  in  the  bond 
forms  given  on  pages  1.51  and  165.  When  the  interest 
date  approaches,  the  coupon  is  detached  from  the  bond 
and  deposited  in  a  bank  just  as  a  check  on  the  corpo- 
ration would  be  deposited.  In  fact,  the  coupons  are 
practically  simply  post-dated  checks.  Sometimes  cou- 
pon bonds  are  registered  as  to  principal,  in  which  case 
transfer  of  ownership  is  not  made  simply  by  delivery, 
but  must  pass  through  the  books  of  the  company.  The 
interest  coupons,  however,  are  payable  to  bearer.  Fre- 
quently an  issue  of  bonds  may  be  either  coupon  or 
registered  at  the  option  of  the  buyers. 

There  are  obvious  ad\antages  in  each  form.  The 
coupon  form  is  very  convenient,  inasmuch  as  it  may 
readily  be  sold  or  hypothecated.  The  registered  form 
makes  up  in  safety  what  it  lacks  in  convenience.  If 
it  is  lost  or  stolen  it  can  be  negotiated  only  by  a  forgery 
of  the  signature  of  the  person  in  whose  name  it  stands, 
in  which  case  the  transfer  would  not  be  valid.  When  a 
coupon  bond  is  lost  or  stolen  and  is  once  sold  to  an 
innocent  purchaser  for  value,  the  original  owner  must 
stand  the  loss. 

A  gold  bond  is  one  which  specifies  that  payment  of 
principal  and  interest  shall  be  made  in  gold  coin.  If 
there  is  no  such  provision  it  is  underst(K)d  that  legal 
tender  will  be  acceptable.  There  have  been  times  in 
the  history  of  the  Ignited  States,  notably  during  the 
periods  of  greenback  inflation  and  of  free  silver  agita- 


TYPES  OF  COllPORATION  BONDS 


181 


lion,  when  this  gold  coin  provision  was  regarded  as 
highly  important.  At  present  not  a  great  deal  of 
attention  is  given  lo  it. 

Redeemable  bonds  are  those  which  may  be  redeemed 
at  tlie  option  of  the  corporation  before  date  of  maturity. 
Sometimes  the  selection  of  the  particular  bonds  to  be 
redeemed  is  made  by  lot  and  the  terms  of  redemption 
are  made  attractive  with  a  view  to  appealing  to  investors 
witli  a  speculative  twist  of  mind.  The  wisdom  of  issuing 
redeemable  bonds  is  questionable.  It  introduces  an  ele- 
ment of  chance  which  makes  it  very  difficult  to  figure 
mathematically  their  exact  value  and  which  probably 
tends  to  depress  their  market  price. 

Serial  bonds  are  redeemable  in  series  extending  over 
a  term  of  years. 

90.  Convertible  bonds. — This  is  a  type  of  security 
that  was  revived  a  number  of  years  ago,  and  has  since 
l)ee()me  increasingly  popular.  It  may  be  changed  or 
converted  under  certain  conditions  into  some  other  kind 
of  security — usually  into  stock.  The  privilege  of  con- 
version may  belong  to  any  kind  of  bond,  mortgage, 
del)enture,  collateral  trust  or  income.  The  usual  ar- 
ran/^ement  is  to  permit  a  mortgage  bond  to  be  ex- 
changed for  preferred  stock  of  the  issuing  corporation 
at  a  prescribed  rate  of  exchange  and  within  a  certain 
definite  period. 

For  instance,  the  Union  Pacific  Railroad  issued  in 
1001,  $100,000,000,  of  4  per  cent  bonds  which  were  con- 
vertible into  common  stock  at  par.  As  Union  Pacific 
coiiiinon  sold  in  1007  and  1908  at  an  average  price  much 
higher  than  par,  practically  all  of  this  issue  was  con- 
verted long  before  the  expiration  of  the  time  limit  set. 

The  advantage  of  this  scheme  is  that  it  gives  bonds  a 
speculative,  in  addition  to  their  investment,  value.    The 


182 


CORPORATION  FINANCE 


V* 


buj'er  figures  that  he  gets  as  safe  an  investment  security 
as  he  would  have  if  there  were  no  such  privilege  and  in 
addition  he  may  share,  if  he  chooses,  in  any  great  up- 
ward movement  of  the  stock.  The  privilege  of  converti- 
bility enables  the  company  to  borrow  at  a  lower  rate  of 
interest.  A  further  advantage,  from  the  corporation's 
standpoint,  is  that  the  company  if  successful  may  expect 
to  be  relieved  by  the  process  of  conversion  of  the  pay- 
ment of  interest  on  the  bonds.  Thus  room  will  be  made 
for  additional  future  issues  of  bonds,  if  such  issues  are 
regarded  as  necessary. 

From  the  investor's  point  of  view  the  advantages  of 
convertible  bonds  are  summed  up  in  a  circular  by  Mr. 
Henry  Hall  issued  in  :March,  1909.  Notice  that  this 
circular  recommends  the  bonds  to  the  semi-investing 
rather  than  to  the  strictly  investing  public. 

Convertible  bonds  belong  to  the  sounder  class  of  speculative 
investments,  combining  a  reasonable  degree  of  safety  and  cer- 
tainty of  interest  return,  with  possibilities  of  substantial  en- 
hancement in  value.  Investors  make  from  25  to  60  per  cent 
profit,  sometimes  more,  on  convertible  bonds  when  properly 
bought. 

Convertible  bonds  were  first  issued  in  this  country  forty  and 
fifty  years  ago,  when  the  financing  of  even  the  most  promising 
of  American  railroads  and  at  a  high  rate  of  interest  was  a  diffi- 
cult matter,  and  when  it  was  occasionally  necessary  to  offer 
special  in<lucements  to  ensure  the  success  of  a  new  loan.  Most 
of  the  financing  of  St.  Paul,  for  instance,  for  twenty  years 
or  more  after  1860,  was  accoinplished  through  the  issue  of  this 
class  of  bonds.  It  is  said  that  as  late  as  1896,  there  were  yet 
outstanding  twelve  separate  convertible  issues  of  the  St.  Paul. 
From  1880  to  1900,  few  or  no  issues  of  convertibles  were  made; 
but  the  requirements  of  the  railroads  then  became  so  imperative 
and  the  multiplicity  of  competing  issues  became  so  great,  that 
in  1900  an«l  1901  the  convertible  idea  was  once  more  resorted  to. 


TYPES  OF  CORPORATION  BONDS 


183 


In  a  general  way,  convertible  bonds  tend  always  to  follow 
the  price  of  the  stock  for  which  they  are  exchanged.  This  ten- 
(Kiuy  is  clearly  exhibited  by  the  quotations  in  this  circular. 
Their  fluctuations  in  price  arc  therefore  more  lively  than  those 
of  staid  first  mortgage  and  other  strong  issues.  An  ordinary 
bond  of  good  standing  seldom  moves  more  than  6  to  10  points 
from  year  to  year,  while  convertibles  are  apt  to  fluctuate  from 
10  to  30  points  in  a  single  twelve  months.  The  Erie  4)S,  Series 
A,  fell  from  109%  in  one  year  to  46y2  in  the  next  and  then 
rose  to  soy-. 

Convertible  bonds  are  always  a  direct  obligation  of  the  com- 
pany. Some  of  these  issues  are  secured  by  mortgage.  Others 
arc  not,  but  this  latter  fact  does  not  necessarily  impair  their 
value.  It  merely  suggests  a  careful  scrutiny  of  general  condi- 
tions and  the  business  of  the  company  before  buying  them. 

Of  course  there  are  corresponding  disadvantages. 
Tlie  stockholder  may  well  say  that  if  the  company  is 
going  to  be  successful  it  would  be  far  better  to  let  the 
bonds  stand  and  thus  save  more  of  the  income  for  the 
stockholders.  On  the  other  hand,  if  the  company  is  not 
successful,  the  bonds  will  not  be  converted  into  stock. 
The  stockholder  sees  loss  for  himself  in  either  alterna- 
tive. This  would  perhaps  be  an  unanswerable  argu- 
ment, if  it  were  not  for  the  fact  that  the  bonds  are  almost 
always  offered  at  less  than  market  prices  to  stockholders, 
so  that  the  holders  of  convertible  bonds  and  the  holders 
of  stock  are  likely  to  be  the  same  persons;  or  at  least  the 
stockholder  gets  a  valuable  privilege  in  the  form  of  a 
right  to  subscribe  to  the  bond  issues.' 


CHAPTER  XII 

CORPORATE  PROMOTION— THE  NEW  ENTERPRISE 

91.  The  function  of  a  promoter. — A  promoter  is  a 
man  who  organizes  a  new  business  and  sets  .  *?oing. 
The  business  need  not  necessarily  take  the  fo.m  of  a 
corporation.  It  may  be  handled  as  a  partnership  or  a 
joint  stock  company.  As  new  enterprises  at  the  present 
time,  if  of  any  magnitude,  are  almost  always  conducted 
by  corporations,  however,  it  will  be  convenient  and  not 
far  from  the  truth  to  speak  as  if  the  work  of  a  promoter 
were  confined  to  organizing  and  financing  corporations. 

The  promoter  is  necessary  because  the  great  mass  of 
the  funds  used  in  large  corporate  enterprises  is  passive; 
that  is  to  say,  the  owners  of  investment  funds  are  not 
primarily  engaged  in  buying  and  handling  business 
enterprises.  They  wait  until  a  good  proposition  is 
presented  to  them.  The  function  of  the  promoter,  there- 
fore, is  to  bring  his  proposition  to  the  attention  of  the 
owners  of  funds  in  such  a  manner  as  to  arouse  their 
interest  and  confidence  and  induce  them  to  buy  the 
securities  of  his  new  corporation. 

The  word  promotion  has  a  tinge  of  discredit  attached 
to  it,  partly  because  the  promoter,  from  the  very  nature 
of  his  work,  is  apt  to  be  over-sanguine  and  a  little  care- 
less as  to  exact  accuracy,  and  partly  because  the  high- 
sounding  word  promotion  is  used  by  many  swindlers 
who  prey  upon  ignorant  and  foolish  speculators. 

One  of  these  last  mentioned  gentry  describes  his  op- 
erations in  the  following  words: 

184 


CORPORATE  PRO^IOTION 


185 


Today    the    peomoter — the    20th    Century    genii — takes 
tin  existent  business  enterprise,  and,  for  every  five  dollars  it 
annually  earns,  gives  it  immediately  ninety-fivt  dollars.     He 
takes  an  Opportunity — an  intangible,  impalpable  thing — and 
from  it  creates  an  actuality,  a  vigorous  growing  enterprise  that 
showers  wealth  and  happiness  on  thousands.     He  takes  appar- 
ently irreconcilable  interests,  waves  his  promotion  wand  above 
Hum,  and  presto!  they  become  associated  by  the  bands  of  com- 
mon interest ,  loyal  to  a  single  standard.    Over  business  men  he 
throws  a  mantle  that  protects  their  private  means  against  bank- 
ruptcy, litigation  or  ruin.     He  carries  a  veritable  Aladdin's 
I mnj^the  Lamp  of  Knowledge,  the  Lamp  of  Power,  through 
wliich  he  conjures  opportunities  into  actualities,  small  busi- 
nesses into  larger     His  powers,  legitimately  employed,  upbuild 
industry.     Literally,  in  service  to  humanity,  he  stands  with 
powers  as  beneficent  as  those  exhibited  by  the  Good  Genii  of  our 
(hildhood  tales. 

Tlie  end  of  this  quotation,  when  applied  to  men  whose 
sole  object  is  to  draw  into  their  own  pockets  as  much  as 
t'.icy  can  of  the  savings  of  their  credulous  victims,  is 
sufficiently  absurd.  But  when  it  is  restricted  to  the  true 
promoter,  a  man  whose  judgment  and  business  instincts 
are  sound  and  whose  persuasive  powers  are  used  to 
secure  funds  for  a  legitimate  business  enterprise,  the 
statements  are  not  at  all  exaggerated.  The  promoter 
does,  in  fact,  perform  highly  important  tasks  and  often 
richly  deserves  the  great  rewards  which  fall  to  his  share. 
Many  of  the  great  business  men  of  America  are  pro- 
moters—though, as  noted  in  the  next  chapter,  such  men 
do  not  usually  spend  all,  or  even  most,  of  their  energies 
in  promotion.  To  this  class  belonged  the  men  who  be- 
tween 1000  and  1907  formed  great  influstrial  "trusts." 
including  H.  H.  Rogers,  John  W.  Gates,  D.  G.  Reid, 
W.  H.  Moore.     Closely  allied  with  them  were  finan- 


ssa 


186 


CORPORATION  FINANCE 


It 

r  4, 


ciers  like  J.  P.  Morgan,  E.  H.  Harriman,  George  F. 
Baker  and  James  Stillman. 

92.  "Discovery"  of  a  proposition. — A  promoter  in 
handling  an  enterprise  has  three  separate  tasks  before 
him.  First,  he  must  "discover"  his  proposition ;  second, 
he  must  "assemble"  it;  third,  he  must  "finance"  it. 

The  discovery  of  a  proposition  does  not  mean  simply 
to  find  it,  but  includes  a  thorough  investigation  into  all 
the  surrounding  conditions,  and  the  solution  in  advance 
of  all  the  difficult  problems  that  are  likely  to  arise  in  its 
development.  Let  us  suppose,  for  instance,  that  a  new 
invention  which  looks  good  on  the  surface  is  brought  to 
the  attention  of  a  promoter.  If  he  understands  his  busi- 
ness he  will  first  of  all  examine  critically  every  factor 
that  points  toward  the  invention's  success  or  failure. 
He  will  find  out  whether  it  is  patented  and  just  what 
features  the  patent  covers.  If  it  is  not  patented,  he  will 
make  sure,  through  a  competent  patent  attorney,  that 
the  device  is  actually  new  and  patentable.  If  he  is 
prudent  he  will  probably  instruct  the  attorney  to  find 
out  whether  any  similar  invention  is  used  in  foreign 
countries  or  not.  Next,  he  will  consider  whether  other 
devices  are  in  use  which  perhaps  accomplish  the  same 
purpose  as  well  or  nearly  as  well  as  the  invention.  After 
making  sure  that  the  invention  is  what  it  purports  to  be, 
he  will  consider  the  possible  markets  for  the  article. 
The  invention  may  be  a  new  machine  that  could  be  used 
in  only  a  few  concerns,  and  perhaps  these  concerns 
would  prefer  to  retain  their  present  machines  rather 
than  expend  any  great  amount  of  money  for  something 
new.  In  this  connection  the  promoter  will  have  to  find 
out  whether  any  incidental  expenses  are  necessary  in 
connection  with  the  use  of  the  invention.  Generally 
speaking,  the  slighter  the  change  from  current  methods, 


CORrORATE  TROMOTION 


187 


S-"> 


the  more  readily  the  invention  may  be  marketed.  The 
a.noiint  of  advertising  and  selling  expense  called  for 
must  also  be  taken  into  account. 

Next,  the  promoter  takes  up  the  cost  of  manufactur- 
ing. He  finds  out  whether  new  and  specially  con- 
stmcted  machinery  is  necessary  in  manufacturing  the 
invention,  and  whether  any  especial  skUl  on  the  part  of 
laborers  is  required.  He  considers  the  amount  of  expe- 
riment that  will  be  necessary  in  order  to  perfect  the 
invention  and  in  addition  figures  a  large  amount  of 
extra  cost  for  unforeseen  contingencies. 

These  are  only  a  few  of  the  factors  that  the  promoter 
would  investigate  before  taking  any  further  action. 
Their  number  is  sufficient  to  indicate,  however,  that  any 
promoter  who  has  a  reputation  to  make  or  preserve,  can- 
not afford  to  jump  hastily  at  whatever  proposition  is 
presented  to  him.  The  process  of  discovery  may  take  a 
long  time,  perhaps  months  or  even  years. 

The  case  just  cited  is  comparatively  simple.  Where 
a  promoter  is  dealing  with  such  an  enterprise  as  a  new 
railroad  or  a  new  mine  or  with  a  consolidation  of  manu- 
facturing plants,  he  is  confronted  by  a  far  more  com- 
plicated situation.  If  the  investigation  is  thorough  and 
searching,  the  promoter  will  be  able  to  give  a  well- 
jrrounded  and  satisfactory  answer  to  every  question  that 
ijrospective  buyers  may  raise. 

93  "Assembling"  a  proposition.— By  assembling  a 
proposition  is  meant  the  process  of  getting  temporary 
control  into  the  hands  of  the  promoter.  If  he  is  dealing 
with  an  invention,  he  assembles  the  proposition  by  get- 
ling  an  option  on  the  invention  or  by  making  an  agree- 
ment with  the  inventor  on  a  royalty  basis.  In  the  case 
of  a  consolidation  of  plants  or  railroads  into  a  new  cor- 
poration, assembling  is  frequently  much  more  compli- 


II 


!l 


188 


CORPORATION   FINANCE 


cated  and  difficult.  In  such  a  case  the  promoter  may 
have  to  get  options  or  arrange  the  terms  of  purchase 
with  every  plant  and  perhaps  with  all  the  different 
classes  of  security-holders  involved.  Unless  a  promoter 
has  these  agreements  or  options  in  his  own  hands,  it  is 
as  a  rule  foolish  for  him  to  go  ahead  with  any  further 
efforts.  He  might  complete  his  arrangements  for  put- 
ting the  new  corporation  on  its  feet  and  then  find  that 
in  the  meantime  the  original  owners  of  the  property  had 
sold  to  other  parties  or  had  taken  steps  that  would 
diminish  the  value  of  the  property.  Or  he  might  find 
that  after  forming  the  corporation  and  bringing  the 
owners  of  the  funds  and  the  owners  of  the  property 
together,  they  would  mutually  agree  to  dispense  with 
his  services  and  would  leave  him,  so  far  as  his  compen- 
sation is  concerned,  out  in  the  cold. 

94.  Financing  a  proposition. — The  initial  develop- 
ment.— Now  we  come  to  the  most  difficult  part  of  the 
promoter's  work,  his  financing  of  the  new  corporation. 
No  hard  and  fast  rules  can  be  laid  down  to  cover  the 
promoter's  procedure.  There  are  some  general  prin- 
ciples, however,  which  apply  to  all  enterprises  and  which 
should  always  be  kept  in  mind. 

First,  it  is  advisable  in  practically  every  case  to  de- 
velop the  proposition  as  far  as  possible  with  the  pro- 
moter's own  resources  and  those  of  his  immediate  friends 
before  it  is  presented  to  outsiders.  In  making  this 
statement  it  is  assumed,  of  course,  that  the  promoter 
really  has  faith  in  his  proposition  and  is  willing  to  take 
whatever  risk  is  mvolved  in  developing  it ;  otherwise  the 
promoter  will  naturally  spend  as  little  as  possible  of  his 
own  money.  In  the  case  of  an  invention,  for  instance, 
which  the  promoter  is  trying  to  finance,  it  is  far  better 
to  have  the  invention  actually  manufactured  and  a  few 


CORPORATE  PROMOTION 


189 


of  the  articles  on  exhibition  before  any  attempt  is  made 
to  interest  outside  capital.  If  this  is  impossible,  a 
working  model  at  least  should  be  on  hand.  The  average 
capitalist  is  not  likely  to  part  with  his  money  unless  he 
sees  before  him  something  more  tangible  and  impressive 
than  a  verbal  description  of  what  the  inventor  expects 
his  as  yet  unborn  machine  to  accomplish. 

If  a  promoter  is  financing,  let  us  say,  a  copper  mine, 
lie  should  do  his  utmost  to  have  the  ore  bodies  opened 
up  and  mining  operations  started,  even  if  only  on  a 
small  scale,  before  he  starts  to  float  his  corporation. 
Where  the  promoter  is  consolidating  several  existing 
plants  he  already  has  some  of  his  exhibits  at  hand  in 
the  form  of  the  going  plants  and  companies  that  are  to 
be  consolidated.    Nevertheless,  the  combination  itself  is 
in  reality  a  new  enterprise  and  the  promoter  should 
spare  no  pains  to  secure  some  practical  demonstration 
of  its  profit-making  possibilities.     Sometimes  he  may 
point  to  the  success  of  previous  combinations  created 
under  closely  similar  conditions.    If  he  does  not  have 
examples,  at  least  he  can  get  exact  figures  as  to  the 
selling,  admmistrative  and  operating  expense  under  the 
present  arrangement  which  would  be  saved  if  the  com- 
bination were  effected. 

In  general  the  promoter  must  bear  in  mind  that  an 
enterprise  which  exists  only  on  paper  does  not  make 
anything  like  as  powerful  an  appeal  to  the  buyer  of 
securities  as  an  enterprise  which  has  something  tangible 
to  show.  It  may  be  that  the  standing  and  prospects  of 
ihe  enterprise  are  in  reality  very  little  changed  simply 
by  producing  some  tangible  results.  Xevertheless,  the 
confidence  of  people  with  funds  is  much  increased  and 
this,  after  all,  is  the  promoter's  main  object. 


lao 


CORPORATION  FINANCE 


95.  Foresight  in  providing  funds.-  -Second,  the  pro- 
moter should  take  care  not  to  get  his  enterprise  into 
such  a  condition  that  funds  must  he  secured  immedi- 
ately on  whatever  terms  are  demanded.  This  is  a  situa- 
tion that  is  quite  apt  to  confront  one  who  goes  ahead 
with  construction  and  development  too  rapidly.  In  his 
eagerness  to  make  a  favorable  showing  he  may  perhaps 
run  short  of  funds,  find  the  obligations  of  his  cor- 
poration pressing  and  be  compelled  to  make  some  very 
disadvantageous  deals  or  see  his  corporation  go  into 
bankruptcy.  Many  a  meritorious  enterprise  has  suf- 
fered this  fate. 

To  prevent  such  a  catastrophe  the  promoter  should 
see  that  his  corporation  is  capitalized  for  a  krger 
amount  than  he  expects  to  need ;  thus  there  will  always 
be  unused  securities  which  mav  be  offered  for  sale  with- 
out  involving  tedious  and  unnecessary  formalities.  It 
may  be  well  to  have  this  stock  actually  issued  and  trans- 
ferred to  the  treasurer  of  the  company  in  the  manner 
which  has  been  previously  described. 

Furthermore,  the  promoter  should  endeavor  to  raise 
in  advance  of  any  expensive  construction  or  develop- 
ment all  the  funds  that  will  be  recjuired  for  that  purpose. 
The  corporation  which  has  a  factory  half-built,  or  min- 
ing machinery  partially  installed,  or  merchandise  busi- 
ness half-stocked,  is  in  an  extremely  precarious  condi- 
tion. AVithout  additional  funds  it  can  go  neither 
backward  nor  forward.  It  has  no  valuable  assets  or 
established  trade  on  which  to  borrow  funds,  it  has  no 
trade  credit,  it  has  no  record  of  sales  and  profits  to  pre- 
sent to  ])ros])ective  buyers  of  securities.  It  is  therefore 
unable  to  secure  any  funds  except  from  some  individual 
or  small  group  who  may  come  to  its  rescue.  The  pro- 
moter mav  feel  reasonably  confident  that  their  assistance 


CORPORATE  PROMOTION 


191 


will  be  purchased  only  with  the  sacrifice  of  his  own 
control  and  probably  of  most  of  his  profits. 

96.  Advantages  of  a  wide  distribution  of  stock.— 
Third,  it  is  usually  far  better  both  for  himself  and  for 
the  corporation  that  the  promoter  sell  his  securities  to  a 
large  number  of  small  buyers  rather  than  to  a  small 
number  of  large  buyers.    In  the  former  case  the  stock- 
holders are  scattered  and  their  holdings  are  too  small  to 
induce  them  to  take  any  active  interest  in  the  busmess. 
Consequently  the  promoter,  even  if  he  fails  to  retain  a 
majority  of  the  voting  stock,  is  left  in  absolute  control. 
In  the  second  case,  the  promoter  is  watched  and  perhaps 
hampered  by  the  large  stockholders;  even  if  he  holds  a 
majority  of  the  voting  stock,  he  will  probably  not  desire 
to    arouse    their    objections    and   will    therefore    feel 
obligated  to  consult  them  or  their  representatives.    Such 
an  arrangement  the  promoter  who  has  faith  in  his 
own  abilities  and  ideas  does  not  desire.     He  usually 
feels  that  he  understands  i'      ^proposition  better  than 
anyone  else  and  that  to  bin    should  be  left  the  con- 
duct of  the  business  until  it  is  well  started  toward 
success. 

From  the  standpoint  of  the  corporation,  u  large  num- 
ber of  small  stockholders  is  almost  always  desirable. 
The  wider  the  distrib\ition  of  the  stock,  the  more  friends 
the  corporation  has  and  the  easier,  probably,  will  be  the 
selling  of  additional  securities.  Besides,  the  large 
capitalists  who  might  be  interested  in  the  enterprise, 
should  generally  be  kept  in  reserve  for  such  emergencies 
as  have  been  described.  If  the  corporation  does  get  into 
difficulties,  in  spite  of  all  the  care  that  its  promoter  may 
take,  it  can  then  turn  as  a  last  resort  to  these  capitalists 
instead  of  drifting  helplessly  into  insolvency 
97.  "Starting  right*'  in  the  sale  of  stock.— Fourth,  if 


1! 


192 


CORPORATION  FINANCE 


the  promoter  is  handling  a  legitimate  small  enterprise, 
he  should  look  for  his  funds  to  the  people  of  the  locality 
where  the  enterprise  is  started.  If  the  enterprise  is  too 
large  for  them,  at  least  he  should  accomplish  his  pre- 
liminary financing — that  is,  the  raising  of  sufficient 
funds  to  get  the  enterprise  started,  although  not  enough 
to  carry  it  on  to  success — among  the  local  people.  Con- 
servative bankers  and  business  men  always  recognize  the 
superior  opportunities  for  getting  exact  information  of 
local  investors  and  have  considerable  confidence  in  their 
judgment.  It  is  a  great  advantage  to  a  promoter  in 
presenting  his  enterprise  to  the  public  to  be  able  to  say 
that  a  large  part  of  the  funds  have  been  subscribed  by 
persons  who  are  on  the  ground  and  in  close  touch  with 
what  is  actually  being  accomplished.  The  same  ob- 
servations apply  to  people  with  technical  training  if  the 
enterprise  has  many  difficult  technical  features.  The 
promoter  of  a  corporation  to  manufacture  a  new  elec- 
trical engine,  for  instance,  ought  to  have  the  support 
of  experts  in  that  field — manifested  not  only  in  words, 
but  by  money — before  he  starts  his  campaign  for  sub- 
scriptions among  outsiders. 

98.  A  concrete  illustration. — The  practical  applica- 
tion of  the  principles  here  laid  down  in  the  promotion 
and  financing  of  interurban  electric  railroads  has  been 
well  described  in  a  lectuVe  before  the  students  of  New 
York  University  School  of  Commerce,  Accounts  and 
Finance  by  Dr.  Thomas  Conway,  Jr.,  of  the  University 
of  Pennsylvania.    Dr.  Conway  said: 

The  proposition  havinpf  been  discovered  and  thoroughly  in- 
vestigated, and  the  necessary  options,  for  example  the  rights  of 
way,  etc.,  together  with  the  necessary  franchises,  having  been 
obtained,  the  promoter  arranges  to  present  the  proposition 
to  those  who  will  furnish  the  money  necessary.     He  accom- 


CORPORATE  PROMOTION 


198 


panics  his  statement  of  anticipated  earnings,  with  a  map  of  the 
territory  showing  population  adjacent  and  tributary  to  his 
proposed  lines  and  he  submits  also  engineers'  estimates  of  cost 
of  construction  and  cost  of  operation  based  on  the  amount  of 
traffic,  and  the  grades  and  curves  which  will  be  encountered. 
He  is  now  ready  to  arrange  for  the  financmg  of  his  proposition. 
His  first  step  is  to  organize  a  corporation,  usually  under  the 
laws  of  a  state  in  which  his  road  expects  to  operate.    This  cor- 
poration will  be  organized  with  the  minimum  capital  permitted 
bv  laws  of  the  state  in  order  to  save  initial  taxes  payable  to  the 
state.     It  will  be  organized  with  a  minimum  amount  of  cash 
payment  and,  if  possible,  requirements  for  actual  contributions, 
will  be  satisfied  by  turning  in  options  to  the  company.     The 
charter  of   the   company   contains   the   authorization  of  the 
amount  of  capital  which  will  be  required  to  finance  the  enter- 
prise.    This  capital  consists  of  bonds,  preferred  and  common 
stock.  It  is  important  that  the  amount  of  bonds  per  mile  of  road 
should  be  kept  down  to  the  lowest  practicable  figure  as  a  large 
bonded  debt  immediately  arouses  a  suspicion  and  suggests  the 
advisability  of  a  more  skeptical  and  scrutinizing  investigation 
of  the  promoter's  representations.     The  amount  usually  fixed 
upon  as  conservative  is  $20,000  per  mile.    This  may  be  exceeded 
in  cases  of  especially  expensive  construction  where  interest  on 
an  excessive  amount  may  be  offset  by  lower  cost  of  maintenance. 
The  preferred  stock  issue  is  usually  for  subscription  in  the 
immediate  locality  where  interest  in  the  new  proposition  must  be 
aroused.      It  is  advantageous  to  secure  the  largest  possible 
amount  in  this  manner,  since  it  gets  down  the  amount  of  bonds 
to  be  sold  and  makes  their  sale  correspondingly  easy.     Two 
courses  of  action  are  now  open  to  the  promoter.    He  may  either, 
after  secqring  the  proper  introductions,  address  himself  to  a 
private  banker  in  some  financial  center  and  oflTer  to  him  the  en- 
tire bond  issue,  or  he  may  arrange  for  the  financing  of  his  enter- 
prise in  his  own  locality,  approaching  the  city  banker  only  after 
ht  has  a  record  of  earnings  upon  which  to  base  his  argument. 
The  invest©    t&  whom  these  securities  must  be  «old,  will  not 
C— VI— 13 


194 


CORPORATION  FlxNANCE 


I 


4 

i 


mm 


buy  the  bonds  of  an  enterprise  whicli  has  no  recognized  status, 
so  long  as  it  remains  in  formation  and  in  chaotic  condition. 
It  is  in  his  eyes  a  speculation  a. id  as  such  he  is  reluctant  to  put 
his  money  into  its  securities.  If  the  bonds  arc,  therefore,  sold 
in  the  city,  to  the  city  banker,  he  must  borrow  the  money  to 
build  the  road,  and  must  hold  the  bonds  until  at  least  a  year's 
operation  of  the  new  property  has  been  completed.  The  city 
banker  will  demand  hard  terms  as  a  condition  of  ad/ancing  this 
money,  if  indeed  one  can  be  found  witli  sufficient  confidence  in 
the  new  enterprise  to  risk  his  capital  in  its  inauguration. 

It  is  better,  therefore,  if  possible,  that  the  promoter  should 
arrange  for  a  preliminary  financing  of  his  scheme  among  local 
interests.  This  he  does  in  the  first  place  by  securing  subscrip- 
tions to  preferred  stock  as  already  indicated.  He  also  obtains 
a  guarantee  of  purchase  of  the  bonds  of  his  corporation  from 
local  interests,  bankers,  institutions  and  capitalists,  with  whom 
he  is  acquainted,  the  condition  of  the  guarantee  being,  that  W 
the  bonds  are  not  sold  within  a  definite  time,  sa}'  three  years, 
above  the  price  named  in  the  contract  of  guarantee,  the  guar- 
antors will  take  them  at  that  price.  Tiie  city  banker  would  usu- 
ally require  that  local  interests  guarantee  at  least  a  portion  of 
the  bonds,  and  it  is  therefore  just  as  well  for  a  promoter  if  he 
can  accomplish  this  to  secure  guarantee  of  the  entire  issue.  In 
order  to  make  the  stock  of  his  company  fully  paid  a  device  fre- 
quently resorted  to  is  that  of  a  construction  company  organized 
by  the  promoter  and  his  friends  and  associates,  who  receive  all 
the  stock  except  what  preferred  stock  may  be  prescribed  for 
bonds  of  the  new  company  in  exchange  for  an  agreement  to 
construct  and  e(juip  its  lines  in  accordance  with  the  plans  and 
specifications  of  the  engineers,  which  are  nuide  part  of  the 
agreement.  At  the  time  this  contract  is  executed,  all  the 
common  stock  and  sometimes  such  a  portion  of  the  preferred  a» 
may  not  have  been  provided  for  is  turned  over  to  the  construc- 
tion company,  togt-tluT  with  a  small  amount  of  the  bond*. 
The  remainder  of  the  bonds  are  issued  to  a  trust  company, 
which  acts  as  trustee  for  the  holders,  in  installments  correspond- 


CORPORATE  PROMOTION 


195 


iii'i-  to  the  completion  of  sections  of  the  lines  as  certified  to  by 
thu  engineers  representing  the  trust  company.     The  promoter 
or  liis  representative,  acting  for  the  construction  company, 
uliicli  has  now  come  into  possession  of  all  the  securities  of  the 
luw  corporation,  arranges  with  some  trust  company  or  bank 
to  (ulvance  sufficient  funds  to  build  and  complete  the  line.    The 
Miurity  offered  is  the  bond  issue  of  the  railroad  company  sup- 
pldiiontcd  bv  the  guarantees  above  mentioned  and  by  a  certain 
aiiiDunt  of  the  stock.    The  common  stock  of  the  railroad  com- 
[liiiiy,  it  should  be  mentioned,  is  divided  up  among  the  guaran- 
tors of  the  bonds.    The  trust  company  advances  the  funds,  the 
Iiiiiikcr  finally  sells  the  bonds,  and  what  rcma'ns  constitutes  the 
jiroiiioter's  profit.     The  amount  of  common  stock,  which  must 
lu   {riven  to  each  Oiic  of  those  interests,  and  that  can  be  re- 
tiiliied  by  the  promoter,  varies  with  circumstances.     In  return 
tor  making  the  loan,  the  trust  company  usually  exacts  a  com- 
n.i>>ion  of  say  2\-i  per  cent  to  5  per  cent,  resides  the  regular 
iiil.  rest  of  6  per  cent  or  in  some  cases  as  high  as  8  per  cent,  the 
louis  running  for  two  years.    This  money  is  advanced  on  serial 
iiotts  of  the  construction  company,  corresponding  to  the  com- 
|)1.  tion  of  different  sections  of  the  roud,  and  secured  by  the 
bonds  which  arc  issued  to  the  construction  company  by  their 
trustee  as  fast  as  the  road  is  completed. 

For  example,  we  will  suppose  that  the  total  amount  of  bonds 
is  !^1, 000,000,  and  that  these  should  be  issued  in  ten  installments 
to  the  construction  company.  The  first  installment  of  $100,000 
is  Issued  at  the  time  the  contract  with  the  railroad  company  is 
(NKuted.  The  construction  company  takes  this  note  together 
with  the  guarantee  of  the  ])urchase  of  these  bonds,  and  $100,000 
of  lunids,  and  borrows  from  the  trust  company  $100,000.  With 
tlii>  .*1 00,000  it  pays  for  the  completion  of  five  miles  of  road. 
Wlun  it  is  certified  to  the  trustee  of  the  bonds  that  this  mileage 
1  l^  been  completed,  another  $100,000  of  bonds  is  issued,  an- 
;*lu  r  note  negotiated  and  in  this  way  by  serial  installments  and 
nol(s,  the  trust  company  in  time  advances  all  the  funds  neces- 
sary to  build  the  line.     Prior  to  the  completion  of  the  linei 


196 


CORPORATION  FINANCE 


,:^: 


ii 


some  portion  of  the  interest  may  be  earned  by  the  sections  which 
may  be  put  into  operation.  It  is  customary,  however,  to  pro- 
vide in  the  original  "apital  issue  sufficient  funds  for  the  payment 
of  one  or  two  years'  interest. 

If  the  calculations  of  the  promoter  have  been  correct,  after 
the  company  has  completed  its  first  full  year  of  operations, 
little  difficulty  will  be  experienced  in  arranging  for  an  advan- 
tageous sale  of  the  bonds  to  the  city  banker.  Some  stock  may 
be  demanded  along  with  these  bonds,  but  the  amount  will  be 
small  compared  with  what  would  have  been  asked  if  the  banker 
had  been  obliged  to  advance  the  money  for  construction.  In 
agreeing  to  take  the  bonds  of  an  intcrurban  electric  railway  the 
banker  is  running  little  risk,  and  is  often  able  to  dispose  of  all 
the  bonds  as  soon  as  he  has  completed  his  payments  for  them. 
These  bonds,  until  the  notes  which  have  been  sen  red  have  been 
paid,  remain  in  the  custody  of  the  trust  company  which  ad- 
vances the  money  to  the  construction  company  as  fast  as  the 
bonds  are  delivered  to  the  banker.  He  makes  payment  for  them, 
and  with  these  funds  the  notes  of  the  construction  company 
are  satisfied  and  all  the  bonds  have  been  taken  up  and  paid  for; 
the  indebtedness  of  the  co;.struction  company  is  discharged,  and 
there  remains  in  its  hands  a  certain  amount  of  cash  and  securi- 
ties which  are  distributed  to  its  stockholders.  The  construc- 
tion company's  work  having  been  accomplished,  it  is  then  dis- 
tiolved. 


lu 


CHAPTER  XIII 

THE  PROMOTER  AND  THE  CORPORATION 

99.  Professional  promoters. — It  is  time  to  say  some- 
thing about  the  promoter,  his  personality,  his  duties,  his 
legal  responsibilities,  the  services  that  he  performs  and 
the  pay  that  he  receives.  Readers  who  are  unfamiliar 
with  the  world  of  finance  may  have  assumed  from  what 
has  been  said  that  a  certain  class  or  group  of  men  make 
it  their  sole  business  to  promote  enterprises  and  that  no 
one  else  ventures  into  this  field.  This  would  be  an  en- 
tirely erroneous  impression.  Anyone  who  is  pushing  a 
money-making  scheme  is  a  promoter  for  the  time  being, 
or  at  least  he  is  performing  some  of  the  functions  of 
a  promoter.  On  the  other  hand,  as  not  everyone  by 
any  means  is  well  fitted  by  temperament,  training  or 
practice  to  make  a  success  of  the  difficult  work  of  pro- 
motion, comparatively  few  men  are  concerned  with  such 
work  to  any  great  extent. 

We  may  classify  the  men  who  spend  a  considerable 
amount  of  their  time  and  energy  in  promotion  into 
four  groups.  Let  it  be  clearly  understood,  however, 
that  this  classification  does  not  pretend  to  be  com- 
plete. 

First  come  the  professional  promoters,  the  men  who 
really  do  make  it  their  main,  and  almost  their  sole,  busi- 
ness to  hunt  for  enterprises  that  promise  profits  and  to 
turn  nee  those  enterprises.  This  type  is  common  in  fic- 
tion, but  rare  in  real  life.  So  far  as  the  writer  recalls, 
he  has  met  only  one  man  who  could  be  put  in  this  class, 

197 


M 


m 

!  -jj 


198 


CORPORATION  FINANCE 


m 
m 


I* ' 

I 


t» 


a  tall,  lank,  fervent  individual  with  a  persuasive  air. 
At  the  time  the  writer  knew  him  he  was  engaged  in 
selling  the  stock  of  a  IMexican  rubber  plantation  com- 
pany; he  was  also  interested  with  others  in  the  de- 
velopment of  a  tract  of  real  estate  near  Xew  York  City; 
and  he  was  investigating  the  possibilities  of  a  copper 
mine  in  Xorth  Carolina.  "So  doubt  other  plans  were 
germinating  in  his  mind.  He  was  of  the  enthusiastic, 
visionary  type,  utterly  incompetent  to  manage  an  enter- 
prise but  skillful  in  appealing  to  the  aspirations  and 
emotions  of  others.  On  the  whole,  he  was  fairly  suc- 
cessful; tnat  is  to  say,  he  was  making  enough  money  on 
one  enterprise  to  pay  his  losses  on  the  others  and  to  get 
a  decent  living  in  the  bargain.  lie  was  unquestionably 
honest  in  his  convictions;  indeed,  it  was  easy  for  him  to 
be  honest,  for  he  possessed  a  w.'nd  that  readily  believed 
whatever  he  wished  to  believe.  Probably  he  was  used 
as  a  tool  in  many  cases,  although  he  never  suspected  it, 
by  shrewder  and  less  scrupulous  men. 

It  might  be  said  that  ^Ir.  John  W.  Gates,  Judge  W. 
H.  Moore,  INIr.  Daniel  G.  Rcid,  and  the  others  named 
in  Chapter  XII,  are  professional  promoters.  It  would 
be  more  nearly  correct,  however,  in  the  writer's  opinion 
to  classify  these  men  as  primarily  brokers,  or  lawj'^ers, 
or  bankers,  who  have  won  a  few  great  successes  in  the 
field  of  promotion.  The  man  who  does  nothing,  but 
"promote"  is  not  apt  to  achieve  marked  successes,  one 
reason  being  tliat  the  really  great  opportimities  are  not 
usually  stumbled  upon  by  chance  or  disclosed  to  those 
who  seek  after  them,  but  are  revealed  only  to  those  who 
have  an  intimate  acquaintance  with  the  details  of  the 
business  to  be  promoted.  The  only  exception  to  this 
statement  worth  noting  is  when  one  who  has  already 
achieved  success  as  a  promoter  is  called  in  by  men  who 


PROMOTER  AND  CORPORATION 


199 


tlioroughly  understand  the  business  to  be  promoted  and 
who  place  their  knowledge  at  his  disposal. 

100.  La-wycrs  and  bankers  as  promoters. — The  second 
class  consist  of  lawyers  and  bankers  in  small  commu- 
nities. Such  men  have  exceptional  opportunities  to  in- 
form themselves  as  to  local  conditions;  they  frequently 
take  liold  of  some  local  enterprise,  such  as  a  steam  or 
street  railway,  secure  the  assistance  of  experts  for  inves- 
ti«iation  and  carry  through  the  proposition  to  success. 
sun  more  frequently,  however,  so  far  as  the  writer  has 
observed,  such  men  underestimate  the  difficulties  of  the 
problem;  they  take  it  up  with  enthusiasm  but  are  forced 
either  to  drop  it  or  to  call  in  men  of  wider  experi- 
ence. 

The  men  to  whom  they  generally  turn  constitute  the 
tliird  class  of  promoters,  namely  the  larger  bankers  and 
brokers.  The  amount  of  promotion  work  performed 
by  such  men  is  limited  and  they  usually  confine  their 
active  participation— except  for  advice— to  the  financ- 
ing- of  such  enterprises  as  they  take  up.  The  late  Mr. 
J.l'ierpont  Morgan  stood  out  as  the  most  prominent  ex- 
ample of  this  class. 

101.  Engineering  frms  as  promoters.— The  fourth 
class— and  this  is  a  recent  important  development- 
consist  of  engineering  firms  engaged  in  construction 
work  of  various  kinds.  Certain  large  engineering  con- 
cerns have  established  a  wide  reputation  for  success  in 
operating  street  railroads,  water  works,  electric  lighting 
plants,  and  so  on.  These  firms  naturally  have  built  up 
a  large  and  well-equipped  staff  of  experts  in  those  fields. 
As  the  staif  is  expensive,  it  becomes  a  pressing  problem 
to  keep  them  profitably  employed  all  the  time.  In  the 
effort  to  solve  this  problem  such  firms  have  drifted 
into  the  custom  of  taking  up  new  enterprises  of  merit 


200 


CORPORATIOx\  FINANCE 


in 


m 


■U-Jfj 


W 


and  performing  the  work  of  promotion  themselves. 
Their  prime  object  in  so  doing  is  to  employ  their  own 
engineering  talents  and  +hc  abilities  of  their  staff  to  the 
best  advantage.  Incidentally,  of  course,  they  have  no 
objection  to  securing  some  of  the  other  returns  that 
naturally  follow  from  successful  promotion. 

These  engineering  promoters  have  three  great  ad- 
vantages which  have  told  heavily  in  their  favor: 

(1)  They  are  able  to  carry  on  a  thorough  investiga- 
tion of  any  project  that  is  presented  to  them  without 
much  extra  expense;  and  as  they  are  constantly  engaged 
in  such  investigations,  they  have  developed  a  body  of 
experts  who  are  able  to  give  the  best  possible  judgment 
as  to  the  outlook  for  success  in  each  instance.  Conse- 
quently they  seldom  go  wrong. 

(2)  They  are  almost  invariably  big  enough  and  have 
resources  enough  to  finance  the  projects  which  they 
undertake  themselves,  if  necessary.  However,  as  they 
are  primarily  engineers,  not  financiers,  they  nearly  al- 
ways prefer  to  secure  the  greater  part  of  the  funds 
from  other  persons.  This  they  accomplish  by  calling 
to  their  assistance  some  large  banking  and  brokerage 
house,  which  will  undertake  to  sell  the  securities  of  the 
corporations  organized  by  the  engineering  firms.  The 
alliance  thus  formed  is  of  great  advantage  to  the  bank- 
ing house,  inasmuch  as  it  may  accept  with  confidence 
the  results  of  the  investigation  carried  on  by  the  engi- 
neering firm's  experts. 

(8)  The  engineering  firm,  having  a  reputation  to 
acquire  and  sustain,  does  not  desert  the  new  enterprise 
as  soon  as  financed,  as  most  promoters  do,  but  sticks  with 
it  until  it  is  a  thor(>ughly  established  success.  The  en- 
gineering firm  must  have  on  its  staff  experts,  not  only 
in  planning  and  building  the  street  railroad  or  power 


PROMOTER  AND  CORPORATION 


201 


plant  or  whatever  the  new  project  may  be,  but  also  in 
operating  the  enterprise.  It  is  in  position,  therefore, 
not  merely  to  put  the  new  corporation  on  its  feet,  but 
to  give  it  a  good  running  start  toward  success.  Fur- 
thermore, if  the  corporation  later  gets  into  difficulties, 
the  engineering  firm  may  be  relied  upon  to  come  to  its 
assistance. 

With  these  advantages  there  is  no  telling  how  far 
the  tendency  toward  promotion  by  engineering  firms 
will  go.  It  would  not  surprise  the  writer  to  see  almost 
all  business  of  this  kind  except  the  large  projects 
turned  over  by  common  consent  within  the  next  few 
years  to  the  well-established  engineering  firms.  No 
doubt,  as  soon  as  this  tei  dency  becomes  well  known, 
cheap  imitators  of  the  reliable  engineering  concerns  will 
come  into  the  field.  This  difficulty,  however,  can  be 
o\ercome,  and  in  the  end  we  shall  perhaps  find  the 
husiness  of  promotion  cleaner,  more  reputable  and  con- 
ducted with  greater  ability  than  under  present  condi- 
tions. 

102.  Secret  profits  are  illegal. — No  mattter  who  the 
promoter  of  any  particular  enterprise  may  be,  it  is  al- 
ways necessary  for  him  to  raise  funds  from  outsiders 
for  his  new  corporation;  and  in  the  process  of  raising 
funds  he  must  make  representations  as  to  the  standing 
and  prospects  of  the  corporation.  He  also  frequently 
enters  into  contracts  on  behalf  of  the  corporation  to  be. 
His  activities  in  both  directions  frequently  raise  knotty 
legal  questions,  which  it  is  important  for  us  to  notice. 

At  law  a  promoter  is  in  an  anomalous  situation,  so 
far  as  his  relation  to  his  corporation  is  concerned.  He 
is  not,  strictly  speaking,  an  agent,  because  an  agent 
must  have  a  principal  and  the  company  promoted  can- 
not be  a  principal  because  it  is  not  yet  in  existence; 


*|: 


202 


CORPORATION  FINANCE 


It  = 


yet  the  courts  have  held  that  his  activities  in  many 
respects  are  analogous  to  those  of  an  agent.  In  addi- 
tion, a  promoter  is  in  a  sense  a  trustee  of  the  interests 
of  the  corporation  that  he  is  organizing.  He  is  under 
obligations  to  do  his  best  for  the  corporation  and  to  act 
always  in  good  faith  for  its  benefit.  Furthermore,  he 
must  disclose  all  the  pertinent  facts  in  connection  with 
the  contracts  and  bargains  that  he  makes  for  the  cor- 
poration to  its  officers  and  stockholders  when  formed. 
Generally  speaking,  secret  profits  and  fraud  on  the  part 
of  the  promoter  are  not  merely  immoral,  but  are  re- 
garded by  the  courts  as  illegal  as  well.  "Where  such 
transactions  are  discovered  the  corporation  may  bring 
suit  and  recover  damages.  Thus  four  cases  given  in 
abstract  below  illustrate  different  phases  of  this  prin- 
ciple. 

1.  B  agreed  to  sell  land  to  X  and  Y,  promoters  of 
a  corporation,  for  $12,000.  He  then  associated  him- 
self with  them  and  the  three  agreed  to  form  a  corpo- 
ration which  should  buy  the  land  for  $40,000,  out  of 
which  B  was  to  receive  tlie  $12,000  he  had  originally  de- 
manded and  in  addition  one-third  of  the  profits  of  pro- 
motion. The  company  was  formed,  the  purchase  price 
of  $40,000  paid  and  the  stock  of  the  company  sold  to 
outsiders.  Subsequently  the  facts  were  discovered  and 
the  company  filed  a  bill  against  the  administrator  of 
B's  estate  for  the  funds  which  B  had  received  over  and 
above  $12,000,  the  ground  of  action  being  that  B,  as 
a  promoter,  was  not  entitled  to  make  a  profit  by  a  sale 
of  his  land  to  the  company  at  a  fictitious  value.  The 
Supreme  Court  of  Pennsylvania  ordered  a  refund  to 
the  company  of  the  amount  received  above  $12,000. 

2.  B  and  C  with  the  object  of  incorporating  a  mining 
company  purchased  oil  lands  for  $10,000,  and  united 


PROMOTER  AND  CORPORATION 


203 


ill  organizing  a  company  to  buy  the  lands  for  $81,000. 
It  was  represented  to  prospective  shareholders  that  B 
and  C  had  purchased  in  the  interest  of  the  company 
and  that  the  price  paid  by  the  company  was  the  same  as 
that  paid  by  B  and  C  to  the  original  owners.  The  cor- 
poration sued  B  and  C  to  recover  the  difference  between 
the  price  paid  in  the  first  instance,  and  the  figure  at 
wliich  the  property  was  turned  over  to  the  corporation, 
and  the  suit  was  successful. 

,3.  In  a  recent  New  York  case  it  was  shown  that  a 
promoter  joined  with  the  owner  of  a  tract  of  land  in 
procuring  options  of  doubtful  validity  on  adjoining 
tracts.  The  promoter  then  organized  a  corporation  to 
purchase  the  land  at  an  advanced  price  under  an  agree- 
ment with  the  owner  that  the  profits  thus  secured  were 
to  be  shared  equally.  The  promoter  bought  the  land 
for  $66,223,  though  the  deed  to  him  recited  $80,000  as 
tlie  purchase  price,  and  conveyed  the  land  to  the  cor- 
poration for  $80,000  and  400  shares  of  stock.  He  sold 
the  stock  to  other  stockholders  and  kept  for  himself 
the  $13,777  profit.  All  of  the  money  paid  to  the 
original  o^vners  of  the  land  belonged  to  the  corporation. 
It  was  held  that  the  corporation  was  entitled  to  the 
$13,777  profits. 

4.  The  promoters  of  a  plantation  company  purchased 
land  in  Cuba  for  $40,000  and  secured  an  option  or  addi- 
tional land  so  drawn  that  it  appeared  they  paid  $20,000 
for  the  option,  making  the  total  purchase  price  appear 
to  be  $60,000.  Tn  fact,  nothing  had  been  paid.  They 
organized  a  corporation  and  represented  to  their  associa- 
ates  that  the  plantation  cost  $60,000.  They  assigned 
their  option  to  the  corporation,  taking  $2,000  in  stock  as 
their  share.  Their  associates  retained  the  balance  of  the 
stock.   It  was  held  that  the  promoters  were  under  a  fidu- 


204 


CORPORATION  FINANCE 


ii 


ciary  relation  to  the  corporation  and  that  the  corporation 
was  entitled  as  against  them  to  the  cancellation  of  the 
stock  so  issued  to  them. 

It  should  be  imderstood  that  there  would  be  neither 
legal  nor  moral  objection  to  a  promoter's  sale  of  prop- 
erty to  his  corporation  at  a  higher  price  than  he  paid 
for  it.  The  only  obligation  resting  on  him  is  that  he 
should  not  conceal  his  profits.  In  practice  it  is  very 
difficult  to  prevent  concealment  and  the  promoter  may 
readily  find  methods  of  making  sworn  statements  as 
to  his  profits  that  will  be  true,  so  far  as  they  go,  but 
will  not  be  the  whole  truth.  A  scheme  much  used  in 
buying  property  that  is  later  to  be  sold  to  the  pro- 
moter's corporation  is  to  have  it  passed  from  the  original 
owners  first  to  another  corporation  owned  by  the  pro- 
moter or  to  a  friend  of  the  promoter;  then  this  corpo- 
ration or  friend  will  sell  to  the  promoter  at  a  price  far 
in  advance  of  what  was  paid  to  the  original  owner  and 
the  promoter  will  be  able  to  assert  that  he  turns  it  over 
to  the  corporation  he  organizes  at  cost  to  himself  or  at 
a  very  small  profit.  Sometimes  the  property  may  be 
made  to  pass  through  two  or  three  intermediate  hands 
in  order  to  make  detection  more  difficult. 

103.  Misleading  statements  constitute  fraud. — An- 
other feature  of  the  promoter's  work  which  should  be 
considered  relates  to  his  statements  with  regard  to  the 
enterpr'<je  whether  made  verablly,  in  correspondence  or 
in  prospectuses.  These  statements  are  subject  to  the 
general  principles  of  the  law  relating  to  fraud.  The 
promoter  is  bound  not  merely  to  make  his  statements 
accurate,  but  not  to  omit  any  facts  of  vital  importance. 

Of  course,  the  same  difficulties  that  are  found  in  all 
applications  of  the  law  relating  to  fraud  are  evident 
here.     The  promoter  may  state  what  he  considers  to 


PROMOTER  AND  CORPORATION 


205 


be  the  facts  and  may  omit  features  that  he  considers 
non-essential  and  it  would  be  impossible  to  prove  that 
his  motives  and  intent  were  not  of  the  best.  We  shall 
see  in  dealing  with  prospectuses  how  easy  it  is  to  give  a 
misleading  impression  without  actually  making  any 
misstatements. 

104.  Contracts  on  hehalf  of  the  corporation  and  their 
acceptance. — Difficulties  sometimes  arise  in  connection 
with  the  contracts  which  a  promoter  makes  on  behalf 
of  his  proposed  corporation.  As  the  promoter  is  not 
an  agent,  he  has  no  right,  strictly  speaking,  to  act  in 
behalf  of  the  corporation.  Courts  of  equity,  however, 
have  modified  this  strict  rule  to  such  an  extent  that  the 
corporation  accepts  the  contracts  by  accepting  its  bene- 
fits. Acceptance  need  not  be  expressed  in  words;  it 
may  be  reasonably  inferred  from  the  acts  of  the  corpo- 
rations. 

105.  The  promoter's  pay. — The  most  vital  questions 
that  arise  between  the  promoter  and  his  corporation 
are:  How  shall  the  promoter  be  paid  for  his  services? 
How  large  shall  his  profits  be?  The  promoter  usually 
feels  that  he  is  entitled  to  all  he  can  get.  The  corpo- 
ration's stockholders,  on  the  other  hand,  are  apt  to  be 
dissatisfied  even  with  a  compensation  that  the  promoter 
considers  exceptionally  small.  The  following  extract 
rom  the  Report  of  the  Industrial  Commission*  states 
the  essential  facts. 

There  are  various  ways  for  the  promoter  to  receive  his  pay. 
In  certain  instances,  as,  for  example,  the  United  States  Rubber 
Company,  the  promoter  received  for  his  work  6  per  cent  of 
the  total  stock  issued,  but  had  to  pay  out  of  this  the  charges  of 
lawyers,  accountants,  appraisers,  and  bankers. 

A  more  usual  form  of  remuneration  is  to  give  the  promo- 

1  Second  volume  on  "Trusts  and  Industrial  Combination,"  page  VIII. 


206 


CORPORATION  FINANCE 


I   i 


*•> 


n 
h 


tor  a  certain  amount  of  stock  with  wliich  to  buy  the  plants  re- 
quired and  to  pay  expenses,  permitting  him  to  retain  the  sur- 
plus for  his  profits.  In  the  case  of  the  Rubber  Goods  Manufac- 
uring  Company  the  syndicate  subscribers  furnishing  cash  re- 
ceived for  each  $100  paid  in  $100  in  preferred  stock  and  $90  in 
common  stock.  The  promoters  had  to  purchase  the  plants  and 
were  given  the  entire  issue  of  preferred  and  common  stock.  If 
they  could  buy  the  plants  for  the  proccds  of  100  per  cent 
of  preferred  stock  and  90  per  cent  of  common  they  made  the 
10  per  cent  of  common  stock  for  their  profit;  if  they  had  to 
pay  more  than  that  sum  their  profits  were  correspondingly 
lessened ;  if  they  could  buy  for  less,  naturally  they  made  more 
than  the  10  per  cent  of  the  common  stock.  They  were  under 
the  express  limitation  that  no  preferred  stock  was  to  be  issued 
in  excess  of  tangible  assets,  and  no  conunon  stock  in  excess  o'  an 
amount  determined  by  the  earning  capacity  of  the  plants,  as 
shown  by  previous  experience,  capitalized  on  a  7  per  cent  basis. 

In  the  case  of  the  American  Smelting  and  Refining  Company, 
syndicate  subscribers  for  each  $100  paid  in  cash  received  $100 
in  preferred  stock  and  $70  in  common  stock.  The  promoters 
received  the  remaining  $30  in  common  stock,  out  of  which  they 
had  to  pay  the  entire  evuensos  of  organization.  They  retained 
the  remainder  for  their  profits.  Speaking  generally  Mr.  Chap- 
man states  that  when  a  financiering  syndicate  receives  for  its 
subscriptions  par  in  preferred  stock  and  sontbthing  less  than 
par  in  common  stock  the  usual  custom  is  for  the  promoters  to 
receive  the  remainder  of  the  common  stock  as  pay  for  their  serv- 
ices and  for  covering  the  costs  of  organization.  In  most  cases 
their  profits  will  depend  upon  the  rigidity  with  which  they  can 
hold  down  their  expense  accounts,  and,  in  many  cases,  where  the 
purchase  of  plants  is  entirely  in  their  hands,  upon  the  skill 
which  they  can  show  in  making  purchases.  Usually,  of  course, 
a  careful  appraisement  has  boen  made  of  plants  beforehand,  so 
that  the  basis  of  the  stock  issue  is  well  known  to  all  parties  in- 
terested in  the  deal.  A  certain  speculative  chance  is  also  often 
given  to  the  promoters  through  the  fact  that  it  is  within  their 


PROMOTER  AND  CORPORATION 


20- 


(iiscrction  to  buy  for  cash  or  stocks  as  they  can  best  make  agree- 
iiunts  with  the  vendors.  In  that  case  they  can  sometimes  make 
much  better  bargains  for  themselves  by  paying  cash,  or,  on  the 
otlier  hand,  by  persuading  the  vendors  to  take  securities,  thus 
lessoning  the  amount  of  cash  that  needs  to  be  paid  out.  It  is 
n^iilarly  the  case  that  the  promoter  receives  his  pay  in  common 
stock. 

Within  the  last  two  or  three  years  there  seems  to  have  been  a 
more  conservative  tendency  shown  by  the  bankers  and  others 
interested  in  financing  the  industrial  combinations.  The  man 
who  advances  money  to  buj'  the  various  plants  is,  in  many  in- 
stances, taking  a  considerable  risk  and  expects  often  to  secure  , 
high  pay  therefor.  The  extent  of  his  pay  is  dependent  never- 
theless largely  upon  his  judgment  as  to  the  future  course  of  de- 
v(h)j)iiient  of  the  business  of  the  combination  in  question.  He 
]ir,utically  buys  securities  of  manufacturing  establishments.  If 
thty  earn  high  dividends  his  earnings  will  be  great,  provided 
he  retains  the  securities ;  if  he  sells  them  his  profits  will  be  de- 
termined by  the  market  rate  of  the  securities,  that  being  de- 
pendent again  in  the  long  run  upon  the  earning  capacity  of  the 
establishments.  The  more  usual  terms  probably,  under  which 
within  the  last  two  or  three  years  the  financial  agreements  have 
hcen  made,  are  that  for  each  $100  cash  paid  in  the  subscribing 
iiienibcr  of  tho  finaiicial  syndicate  receives  par  in  preferred  stook 
with  a  bonus  in  common  stock  equal  to  the  preferred  less  the 
amount  reserved  for  the  pay  of  the  promoter.  This  reserve 
has  sometimes  been  as  high  as  50  per  cent  of  the  common  stock, 
sometimes  30  per  cent,  and  sometimes  only  10  per  cent. 

Instead  of  the  plans  mentioned  above  numerous  others  are  of 
course  found,  especially  where  it  is  more  desirable  to  issue  bonds 
or  where  for  some  reason  it  seems  desirable  to  make  special 
terms,  owing  to  the  peculiar  situation  of  some  of  the  members 
entering  into  the  combination.  Promoters  sometimes  receive 
specified  sums  of  money  for  their  services ;  bankers  practically 
always  have  to  take  for  their  services  a  r*  rcentage  of  the  stock 
or  the  surplus  left  over. 


I.i 


208 


CORPORATION  FINiVNCE 


U 


106.  The  promoter's  risks  and  labors. — Enough  has 
been  said  to  indicate  tliat  the  promoter's  labors  and  risks 
are  heavy.  If  he  does  his  work  thoroughly  he  will 
probably  spend  a  long  time  in  careful  investigation  of 
the  enterprise  and  in  examination  of  all  the  possible 
causes  of  failure  before  he  binds  himself  in  any  manner. 
If  he  is  a  man  of  sound  judgment,  as  he  must  be  in  order 
to  be  successful,  he  will  probably  find  serious  if  not  fatal 
flaws  in  most  of  the  enterprises  that  come  to  his  atten- 
tion. A  professional  promoter  niust  expect,  therefore, 
to  spend  a  large  amount  of  time  and  money  in  studies 
and  investigations  that  bring  him  no  return.  Unless 
this  part  of  his  work  is  thoroughly  done  his  efforts  are 
foredoomed  to  failure. 

In  the  process  of  assembling  his  proposition,  the 
promoter  must  always  take  coniJiderable  personal  risks. 
lie  buys  options,  enters  into  contracts,  and  perhai)s 
spends  money  for  further  experiment,  all  of  which 
will  he  absolutely  lott  unless  his  promotion  proves 
sugcessful. 

In  financing  the  enterprise,  the  promoter  puts  in 
jeopardy  not  only  the  time  and  money  previously  ex- 
pended, but  his  business  reputation  as  well.  One 
notoriously  unsuccessful  jjromotion  will  i)robably  end 
a  promoter's  activities,  at  least  if  he  is  engaged  in  an 
entirely  legitimate  line  of  business. 

107.  Is  the  promoter  overpaid? — It  is  obvious  also 
that  the  promoter  must  possess  a  rare  and  highly  valu- 
able conjbination  of  talents.  He  must  be  keen,  shrewd, 
a  good  bargainer,  farsighted,  prudent,  enthusiastic, 
persuasive,  and,  above  all,  he  must  inspire  confidence. 
With  this  necessary  combination  of  talents,  labnrR  and 
risks,  it  is  not  sur^^rising  that  the  promoter  should  sub- 
sequently claim         exact  large  profits.    It  is  no  doubt 


PROMOTER  AND  CORPORATION 


209 


^ 


true  that  a  considerable  number  of  men  who  have  won 
success  in  this  field  have  made  millions  and  tens  of 
millions  of  dollars  in  a  very  short  time.  To  the  on- 
looker it  sometimes  appears  that  these  millions  almost 
came  dishonestly,  that  it  is  hardly  possible  that  they 
are  legitimate  earnings.  The  average  on-looker,  how- 
i  \  cr,  Ins  no  conception  of  the  amount  or  importance  of 
the  preliminary  work  which  the  promoter  performs. 
.\  either  has  he  any  conception  of  the  large  number  of 
failures  in  this  field.  Probably  the  losses  of  promoters, 
wlio  have  spent  their  own  time  and  both  their  ovm  and 
their  friend's  money  without  benefit  to  themselves, 
would  almost  equal  or  perhaps  exceed  the  total  profits 
of  successful  promotions. 

We  must  not  forget  to  consider  also  the  great  im- 
portance to  business  and  industry  of  their  achievements. 
They  are  the  men  who  have  found  and  developed  the 
inventions,  the  improvements  and  the  better  organiza- 
tion of  industry  which  underlie  our  modern  prosperity. 
Frequently  the  inventor  complains  that  he  has  made 
kss  out  of  his  invention  *hat  did  the  business  promoter; 
the  manufacturer  complains  that  with  all  his  years  of 
(fl'ort  he  has  made  less  out  of  his  factory  than  did  the 
])r()moter  who  takes  it  into  a  bi^  corporation;  the  mine 
owner  complains  that  he  has  made  less  out  of  his  land 
nnd  ore  than  did  the  promoter  who  obtained  the  funds 
for  its  developments.  All  of  these  complaints  are 
natural  enough;  yet  they  all  alike  fail  to  take  into  ae- 
(oimt  the  obvious  fact  that  the  promoter's  efforts  have 
iK.t  done  them  harm,  but  good.  He  has  performed 
for  each  of  them  a  great  service;  and  even  if  he  retains 
the  larger  part  of  the  profits,  they  have  no  just  ground 
for  complaint. 

C_VI-14 


m 


e 


i  -  i 


11 


m 

iiW 
!":ll^ 


CHAPTER  XIV 

CORPORATE   PROMOTION— FORMING 
CONSOLIDATIONS 

108.  The  importaJH'c  of  small  industrial  combinations. 
— Of  late  years  the  most  cdiispiciious  and  i)crhaps  the 
most  imi)ortant  field  for  promoters  has  heen  the  con- 
solidation of  manufacturing?  and  railroad  companies. 
The  tendency  toward  consolidation  has  heen  even  more 
widespread  in  the  last  few  years  than  has  appeared  to 
the  casual  ohserver.  Popular  attention  has  heen 
directed  almost  exclusively  to  what  is  called  the  trust 
movement,  that  is,  the  coml)itiati()ns  of  big  companies 
with  a  view  to  controlling  prices. 

Of  still  greater  importance,  however,  to  the  average 
business  man  has  been  the  tendencv  to  consolidate  small 
local  plants,  not  for  the  sake  of  achieving  even  a  partial 
monopoly,  but  for  the  sake  of  the  economies  that  result 
from  manufacture  on  a  larger  scale  than  is  possible  by 
a  small  ])artnership  or  corporation.  Among  the  most 
important  ec<momies  that  may  be  thus  effected  are: 
first,  the  elimination  of  wasteful  competition  in  selling 
and  advertising;  second,  the  opportunity  to  use  expen- 
sive and  highly  specialized  machinery  more  constantly 
and  therel)y  prevent  the  loss  that  results  from  allowing 
such  machinery  to  lie  idle;  third,  a  position  of  greater 
advantage  to  business  managers  in  their  dealings  with 
labor  unions;  fourth,  brijiging  to  bear  the  best  brains 
nnd  experience  to  be  found  in  any  of  the  plants  con- 
solidated on  the  problems  of  each  plant. 

Xo  statistics  have  been  or  c<»uld  be  collected  to  show 

210 


FORMING  CONSOLIDATIONS 


211 


exactly  the  extent  of  this  movement.  It  is  certain, 
however,  that  the  great  mass  of  the  manufacturing 
cai)ital  of  the  United  States  is  now  employed  by  such 
consolidations  and  that  the  position  of  the  small  isolated 
manufacturer  is  daily  becoming  more  precarious.  In- 
(Ici'd,  the  result  is  inevitable,  for  the  consolidation  can 
usually  effect  the  economics  mentioned  above  without 
e(iiially  great  disadvantages.  The  consolidation,  there- 
fore, although  it  may  have  no  monopoly  and  no  control 
over  prices,  either  of  raw  materials  or  of  finished 
])r()(lucts,  easily  undersells  its  small  competitors.  It  is 
not  worth  while  to  rail  against  such  a  movement ;  busi- 
iuss  men  will  do  bettc "  to  recognize  its  inherent 
strength  and  get  into  line. 

109.  Difficulties  in  the  proinntcr's  taslx. — The  forma- 
tion of  a  consolidation  through  the  medium  of  a  holding 
company,  which  is  the  usual  form  ;  by  no  means  an 
easy  task.  It  brings  into  play  a.,  the  shrewdness, 
!>( rsuasiveness  and  business  judgment  that  a  promoter 
may  possess.  Usually  managers  and  owners  of  the  vari- 
ous plants  to  be  taken  into  the  proposed  consolidation 
arc  so  mutually  jealous  and  antagonistic  that  it  is  next 
to  impossible  for  any  one  of  them  to  effect  a  friendly 
combination  with  all  his  competitors.  Once  in  a  while 
a  successfjil  manufacturer  may  buy  outright  the  securi- 
tiis,  or  perhaps  the  physical  assets,  of  competing  plants; 
init  this  is  an  exception.  Usually  the  promoter  of  a 
consolidation  must  come  from  the  outside.  He  will 
probably  be  better  off  if  he  has  had  no  connection  with 
the  business  and  therefore  has  no  grudges  and  no  prej- 
udices to  overcome.  Sometimes  the  outside  promoter  is 
a  lianker  friendly  with  all  the  interests  to  be  combined; 
sometimes  he  is  a  well-known  promoter  who  has  made 
a  name  for  fair  dealing  and  success;  sometimes  he  is  a 


212 


CORPORATION  FINANCE 


security  holder  in  one  or  more  of  the  concerns  to  be  con- 
solidated, who  has  taken  no  active  part  in  +heir  manage- 
ment. He  will  of  necessity  have  constantly  at  his 
command  the  exper'  lowledge  of  men  directly  con- 
cerned with  the  busuiess. 

For  the  sake  of  simplicity  we  will  first  consider  the 
process  of  consolidating  two  or  more  small  independent 
partnerships  or  corporations  into  a  somewhat  larger 
combination  of  some  local  importance ;  and  after  that  we 
will  consider  the  still  more  complicated  problems  that 
arise  in  the  process  of  forming  a  big  "trust" — using 
that  word  in  the  popular  sense — a  combination  of 
previous  consolidations. 

110.  "Discovery"  of  a  small  consolidation. — In  organ- 
izing a  small  consolidation  the  promoter's  first  step, 
as  has  already  been  indicated,  must  be  a  thorough  inves- 
tigation of  all  the  concerns  which  are  to  be  included. 
Usually  the  promoter  will  not  have  the  time  or  the 
facilities  to  undertake  such  an  investigation  personally 
or  by  means  of  his  own  assistants.  But  he  should 
certainly  be  imwilling  to  accept  the  unsupported  state- 
ments of  the  manufacturers;  he  will,  therefore,  use  the 
services  of  competent  engineers,  of  expert  public 
accountants  and  perhaps  of  lawyers.  The  accountants' 
examination  should  produce  the  most  important  and 
significant  results,  and  on  these  results  the  terms  of  the 
consolidation  will  probably  be  based. 

The  accountant's  work  in  this  connection  should  be 
even  more  extensive  and  searching  than  in  the  case  of 
a  regular  audit.  This  is  particularly  true  because  the 
managers  in  the  case  of  an  audit  presumably  desire  a 
correct  report;  in  the  case  of  this  special  investigation 
their  interests  lead  them  to  favor  over- valuation  of 
assets,  fictitious  accounts  receivable  and  a  padded  in- 


FORMING  CONSOLIDATIONS 


213 


i  1.1 


come  statement.  The  accountant  must  get  an  accurate 
physical  inventory  of  the  property,  if  possible;  he  must 
verify  the  accounts  and  bills  receivable  as  well  as  the 
accounts  and  bills  payable;  he  should  look  into  all  in- 
direct and  contingent  liabilities  with  great  care;  he  must 
see  that  sales  do  not  include  goods  sent  out  "on  con- 
signment" and  "on  approval"  and  that  profits  are  not 
swelled  by  sales  of  what  are  in  reality  capital,  not 
current,  assets. 

111.  Basis  of  consolidation. — The  promoter's  next 
step,  if  he  is  acting  not  simply  on  his  own  account,  but 
as  a  sort  of  arbitrator  for  the  various  manufacturers, 
each  one  of  whom  is  willing  to  go  into  the  consolidation 
on  reasonable  terms,  is  to  draw  up  a  tentative  "basis  of 
consolidation."  In  an  article  in  The  Journal  of 
Accountancy  for  Xovember,  1908,  Mr.  F.  H.  Mc- 
Pherson,  F.  C.  A.,  gives  in  illustration  the  following 
informal  memorandum  of  agreement  which  was  used  as 
a  basis  in  a  certain  consolidation  of  small  companies  with 
which  he  was  concerned.  The  agreement  is  typical  and 
is  well  worth  careful  reading.  It  is  given  in  full  below: 
Basis  of  Consolidation: 

A  corporation  to  be  formed  under  the  laws  of  the  State  of 
Michigan,  with  a  paid-up  capital  of  ten  million  dollars,  to  be 
apportioned  into  6  per  cent  preferred  stock  and  common  stock, 
as  the  parties  interested  may  hereafter  determine. 

This  corporation  to  purchase  all  the  assets,  property,  good- 
will, etc.,  of  all  the  four  companies  and  to  pay  therefor  in  pre- 
ft  rred  and  common  stock  and  by  an  assumption  of  the  indebtcd- 
riLss  of  each  company. 

The  amount  of  preferred  and  common  stock,  to  be  paid  to 
f  nch  company,  to  be  determined  by  the  value  of  the  net  tangible 
assets  and  the  valuation  placed  upon  the  earning  power  of  each 
company. 


214 


CORPORATION  FINANCE 


li 


In  placing  a  value  upon  the  tangible  assets,  same  to  be 
reached  as  follows: 

(1)  The  land,  buildings,  machinery,  tools,  and  patterns,  to  be 
determined  by  appraisers,  to  be  chosen  by  a  majority  of  a 
committee  made  up  of  one  appointed  by  each  of  the  com- 
panies ;  on  failure  of  this  conmn'ttee  to  agree  on  appraisers 
the  selection  to  be  left  to  the  committee  who  present  these 
suggestions. 

(2)  Inventories  of  raw  materials,  work  in  progress  and  manu- 
factured stock  to  be  taken,  and  valuations  placed  thereo 
bj'  the  individual  companies,  and  this  to  be  done  under  the 
supervision  of  a  disinterested  party,  to  be  named  by  the 
committee. 

The  inventories  are  to  be  made  as  of  the  same  date,  and  to 
be  taken  at  substantially  the  same  time. 
When  completed  the  inventories  are  to  be  passed  and 
agreed  upon  by  a  committee  consisting  of  a  representative 
of  each  of  the  companies  and  one  to  be  named  by  the 
committee.     The  decision  of  these  five  to  be  binding. 

(3)  In  reaching  the  value  of  the  earning  })ower  of  the  several 
companies,  consideration  is  to  be  given  to  the  following  de- 
tails: 

(a)  That  profits  are  incidental  to  the  business  and  have  not 
been  anticipated. 

(b)  To  the  charging  to  operating  expenses  of  items,  excep- 
tional or  unusual,  and  which  have  had  the  effect  of  reduc- 
ing profits  below  normal. 

(c)  The  eflfect  upon  the  earnings  of  the  money  paid  out  as 
interest  upon  borrowed  capital,  in  case  it  be  found  that 
the  borrowings  (loans)  made  by  the  several  companies 
are  disproportionate  to  each  other. 

(d)  That  all  charges  to  operating  expenses  are  proper 
charges  against  the  business  and  that  they  are  made  for 
and  during  the  proper  period, 

(c)  That  proper  and  reasonable  allowances  have  been  made 
for  repairs  and  renewals  and  that  these  have  been 
charged  against  earnings. 


FORMING  CONSOLIDATIONS 


215 


(  f )  That  charges  against  earnings  for  depreciation  are  ad- 
justed upon  an  equitable  basis. 

(<r)  Such  other  matters  as  appear  from  an  examination  of 
tlie  accounts  and  which  would  prejudicially  affect  the 
earnings  of  any  of  the  companies,  either  advantageously 
or  disadvantageously. 

(ii)  The  value  of  the  earning  power  to  be  determined  by  a 
consideration  of  the  business  done  by  each  of  the  several 
companies  for  the  three  years,  1903,  1904<  and  1905. 

( i)  Accountants  to  be  selected  by  the  committee  and  ques- 
tions which  may  arise  as  to  treatment  of  various  matters 
and  about  which  there  is  difference  of  opinion,  to  be  de- 
termined by  the  committee. 

(  j)  All  costs  and  expenses  incurred  in  making  appraisals, 
examination  of  accounts,  or  of  performing  the  other 
duties  in  connection  with  the  formation  of  the  proposed 
new  company  to  be  charged  to  and  borne  by  the  new 
company ;  should  the  new  company  not  be  formed,  then 
such  costs,  expenses,  and  disbursements  to  be  borne  by 
the  four  individual  companies  in  proportion  to  the  num- 
ber of  men  employed  by  each. 

It  will  be  noted  that  the  agreement  just  cited  does 
not  specify  just  when  preferred  and  when  common  stock 
shall  be  paid  by  the  holding  company  for  the  securities 
of  the  subsidiary  companies.  One  very  common 
arrangement  is  et  forth  in  the  following  extracts  from 
another  actual  agreement  where  several  fair-sized  man- 
ufacturing corporations  and  partnerships  were  to  be 
consolidated.    This  agreement  provided: 

Each  vendor  executing  tliis  agreement  also  executes  and  de- 
livers a  schedule  of  the  entire  property,  which  it  sells  to  said 
purchaser,  setting  forth  briefly  the  various  classes  of  property, 
with  the  sufficient  description  of  the  several  items  of  real  estate, 
plant  and  movables  to  identify  the  same,  which  schedule  sets 
forth  the  value  of  the  entire  property  so  sold,  the  tangible  and 


■  I   1 
■ 


i: 


216 


coupon ATION   FI N AxXCE 


it  I' 


intangible  propeity  in  separate  items,  the  tangible  property 
being  valued  as  prescribed  by  subdivisions  a  and  b  in  the  Method 
of  Appraisal  hereinafter  set  fortli,  and  the  value  of  its  intan^n- 
ble  property  ascertained  and  certified  by  one  or  more  responsible 
public   accountants,   as   prescribed   by   subdivision   c   of  said 
Method  of  Appraisal,  together  with  a  statement  of  any  addi- 
tional facts,  and  of  the  valuations  bas,  .1  thereon,  which,  in  ilic 
vendor's  judgment,  may  aid  the  Appraisal  Committee  in  exer- 
cising the  discretion  conferred  upon  it  hy  subdivision  b  of  said 
Method  of  Appraisal.     The  valuations  of  the  tangible  and  in- 
tangible properties  so  made  by  each  vendor  shall  be  considered 
as  prima  facie  evidence  of  the  true  value  of  said  vendor's  prop- 
erty for  the  purposes  of  sale,  but  shall  in  no  case  be  controlling 
upon  the  Appraisal  or  Executive  Committee  hereinafter  ap- 
pointed, such  valuations  or  prices  being  subject  in  all  cases  to 
any  investigation  and  modification  which  the  said  committee  or 
committees  may  deem  that  justice  requires;  the  total  of  such 
valuations  as  verified  or  modified  according  to  the  terms  of  this 
agreement,  to  be  the  purchase  price  which  said  vendor  is  to 
receive  for  its  entire  property  so  sold. 

PURCHASE   PRICE 

The  purchase  price  to  be  paid  to  such  vendor  for  the  property 
sold  by  it  to  the  purchaser  shall  be  the  total  value  of  its  tangi- 
ble and  intangible  property  and  shall  be  paid  in  stock  of  the 
purchaser  at  par,  as  follows: — 

1.  Tangible  property  paid  for  in  preferred,  etc. 
Each  vendor  whose  net  earnings  for  the  six  months  ending 
July  1st,  1898,  amount  to  4  per  cent — that  is,  at  the  rate  of 
8  per  cent  per  annum— on  the  value  of  its  land  and  plant, 
ascertained  as  above,  shall  receive  preferred  stock  for  the  full 
value  of  all  its  tangible  property. 

Any  vendor  whose  net  earnings  for  the  said  period  of  six 
months  sfiall  amount  to  less  than  at  the  rate  of  8  per  cent 
per  annum  on  the  value  of  its  land  and  plant,  shall  receive  pre- 
ferred stock  to  the  amount  of  twenty-five  times  its  ret  eft:n- 


e'tt 


FORMING  CONSOLIDATIONS 


217 


ings  for  said  six  months;  and  the  balance  of  the  value  of  said 
tangible   property   it   shall   receive   in   common   stock. 

Each  vendor  has  upon  its  schedule  set  forth  a  statement  of 
its  net  earnings  for  said  period,  which  is  subject  to  modification 
by  said  committee  under  the  above  rules  applicable  thereto. 

2.  Intangible  property  paid  for  in  common  stock. 

The  entire  value  of  the  intangible  property,  ascertained  as 
per  this  agreement,  shall  be  paid  by  the  purchaser  in  its  com- 
mon  stock   at  par. 

Simultaneous  with  the  sale  and  transfer  of  its  properties  each 
vendor  shall  receive  from  the  purchaser  in  stock,  or  if  per- 
manent certificates  are  not  ready,  then  scrip  for  the  same,  one- 
half  of  the  purchase  price  to  which  it  claims  to  be  entitled  by 
its  schedule,  less  an  amount  of  preferred  stock  equal  to  125 
per  cent  of  its  mortgage  indebtedness,  if  any,  and  the  re- 
mainder of  said  stock  shall  be  withhclu  by  the  purchaser  until 
the  exact  amount  of  the  purchase  price  shall  have  been  finally 
determined  as  herein  provided,  whereupon  the  vendor  shall  be- 
come entitled  to  the  remainder  of  the  purchase  price,  but  the 
purchiiser  may  out  of  such  remaining  stock  retain  an  amount 
thereof  sufficient  to  secure  it  against  any  defective  title  and 
against  any  indebtedness  which  is  not  otherwise  suflBciently  pro- 
vided for. 

APPRAISAL,    ETC. 

Each  vendor  expressly  covenants  and  agrees  that  the  prop- 
erty set  forth  by  it  in  its  schedule  has  been  fairly  and  honestly 
valued  in  accordance  with  the  following  rules  and  methods, 
which  shall  be  the  rules  and  methods  to  govern  the  Appraisal 
and  Executive  Committee  in  their  verification  or  modification 
of  the  same. 

METHOD  OF  APPBAISAL. 

(1)  Tangible  Property. 
(a)  Land: 

Land  shall  be  separately  appraised  at  its  actual  value 
without  reference  to  plants  thereon,  and  consideration  shall  be 


218 


lit'" 


CORPORATION  FINANCP] 


[It 


given  to  special  adaptability  or  want  of  adaptability  to  the 
business. 

Plants  shall  be  appraised  apart  from  the  bare  land  at  their 
value  to-day  to  a  going  concern  for  the  purpose  for  which  used, 
based  upon  present  cost  of  construction  at  the  same  places  re- 
spectively. No  vendor  shall  set  forth  in  its  schedule  any  unim- 
proved land  or  other  property  belonging  to  it  which  is  neither 
a  part  of  the  plant  of  such  vendor  nor  essential  in  the  operation 
of  the  same,  nor  shall  the  same  be  purchased  by  the  second  party. 

(b)  Materials,  Supplies  and  Manufactured  Product. 

Thest  shall  be  appraised  at  what  it  would  cost  to  re- 
place the  same  at  the  place  and  date  of  the  transfer  of  the 
same  to  the  purchaser. 
(2)  Intangible  Property. 

(c)  Intangible  property  shall  be  appraised  bj-  multiplying 
by  ten  the  average  yearly  earnings  during  the  past  five  and  one- 
half  years,  which  shall  be  ascertained  as  follows: — 

In  order  to  arrive  at  the  earnings  of  the  property  sold  by 
each  vendor  and  to  determine  on  a  uniform  basis  fair  for  all,  the 
earning  power  of  the  property  so  sold,  each  vendor  shall  add  to 
its  net  profits  such  of  the  following  items  as  huve  been  thereto- 
fore deducted  by  said  vendor  in  ascertaining  its  net  profits  dur- 
ing said  period. 

1.  Interest  on  indebtedness. 

2.  Insurance  of  any  description. 

3.  Arbitrary  items  of  depreciation  or  wear  and  tear  not 
paid  out  or  acluuHy  incurred  as  a  debt  and  all  items  of  new 
construction. 

4.  Also  salo  ries  and  compensation  paid  to  officers,  directors, 
partners,  trui;tees,  superintendents  of  departments  or  works, 
general  managers,  auditors,  cashiers  and  chief  accountants,  but 
all  wages,  salaries  and  ccmpensation  paid  to  laborers,  servants, 
foremen,  clerks  and  employees  in  subordinate  positions  shall  re- 
main charged  against  earnings. 

5.  The  accountants  nmst  ascertain  the  amounts  expended  by 
each  of  said  vendors  for  repairs,  renewals  and  maintenance  of 
I>IaQt  which  have  been  deducted   from  earnings  during  said 


FORMING  CONSOLIDATIONS 


219 


;  m 


period  of  five  and  one-lialf  years,  and  tlic  said  amounts  so  as- 
certained are  set  forth  on  the  schedules  of  said  vendors. 

In  order  to  place  said  vendors  on  a  uniform  basis  as  to  the 
iiiuounts  expended,  or  which  ought  to  have  been  expended,  for 
repairs,  renewals  and  maintenance  of  plant  and  charged  against 
(>r  deducted  from  the  earnings  during  said  five  and  one-half 
vears  or  other  period,  each  vendor  shall  add  to  saic'  earnings 
;iny  amount  actually  expended  by  it  for  repairs,  renewals  and 
maintenance  of  plant  which  it  has  heretofore  charged  against 
and  deducted  from  said  earnings,  and  there  shall  then  be 
charged  against  and  deducted  from  said  earnings  of  each  vendor 
ascertained  as  aforesaid,  annually  a  sum  pqual  to  3  per  cent  of 
the  schedule  value  of  the  plant  of  said  vendor  completed  prior 
to  the  last  date  of  the  five  and  one-half  years  or  other  period 
applicable  to  said  vendor. 

In  the  case  of  those  vendors,  if  any,  which  shall  not  have  kept 
a  separate  repair  account  the  amounts  expended  by  them  for 
repairs,  as  required  by  this  subdivision,  shall  be  ascertained  as 
n^jarly  as  possible  by  the  accountants  and  the  committee  of  ap- 
praisal from  the  books  of  such  vendors  and  from  the  condition 
of  their  plants  and  otherwise,  and  in  default  of  information  to 
the  contrary  it  shall  be  assumed  that  they  have  expended  in  re- 
pairs a  sum  equal  to  3  per  cent  of  the  value  of  their  respective 
plants. 

Having  by  the  foregoing  methods,  ascertained  the  earnings, 
there  shall  thereupon  be  deducted  from  the  average  annual  earn- 
ings of  each  vendor  for  said  period,  a  sum  equal  to  6  per  cent 
(5%)  of  the  value  of  the  land  and  plant  sold  and  completed 
prior  to  the  last  date  of  the  five  and  one-half  years  or  other 
period  applicable  to  such  vendor,  and  the  balance  of  said  aver- 
age annual  earnings  so  ascertained  shall  be  deemed  for  the  pur- 
poses of  this  agreement  the  net  profits  of  the  respective  vendors 
to  be  severally  multiplied  by  ten  as  aforesaid. 

Provided,  however,  that  in  case  it  shall  be  found  that  the 
aforesaid  multiplier  of  ten  will  produce  a  grand  aggregate  of 
common  stock  greater  in  amount  than  the  grand  aggregate  of 
preferred  stock,  the  Executive  Committee  shall  choose  such 


220 


CORPORATION   FINANCE 


I  a 


¥ 


lower  multiplier  as  will  limit  the  grand  aggregate  of  preferred 
stock. 

Provided,  further,  that  in  the  event  that  the  grand  aggregate 
of  the  average  annual  net  earnings  of  the  vendors,  ascertained 
as  aforesaid,  shall  be  found  to  exceed  12  per  cent  of  the 
total  value  of  the  tangible  property,  then  said  Executive  Com- 
mittee in  its  discretion  may  choose  such  multiplier  as  will  fix  the 
i  1 1:  volume  of  common  stock  as  closely  as  may  be  at  an  amount  upon 

which  such  past  net  nearnings  would  show  6  per  cent  applicable 
to  dividends  upon  such  common  stock  after  providing  for  the 
dividend  on  the  preferred  stock. 

And  thereupon  such  newly  chosen  multiplier  (whatever  the 
same  may  be)  shall  be  the  multiplier  to  be  used  in  the  case  of 
each  vendor. 

The  agreement  that  has  just  been  cited  in  part  de- 
serves careful  study.  As  the  extracts  given  are  self- 
explanatory,  however,  it  will  be  left  to  the  reader  to  work 
out  for  himself  the  exact  methods  employed  by  the  pro- 
moters, and  accepted  by  the  owners  of  the  plants  in 
determining  values.  The  substance  of  the  plan,  it  will 
be  seen,  is  that  tangible  property  is  to  be  represented  by 
preferred  stock  in  the  consolidation  and  additional 
earning  power  by  common  stock.  This  puts  the  consol- 
idation, so  far  as  capitalization  is  concerned,  on  a  con- 
servative basis.  The  same  plan,  slightly  modified,  is 
widely  used. 

112.  The  necessity  for  ca*^.— Having  investigated 
and  assembled  his  proposed  consolidation,  the  promoter 
must  next  arrange  for  its  financing.  It  may  be  said  at 
this  point  that  the  basis  of  consolidation  in  itself  finances 
the  new  consolidation,  inasmuch  as  it  provides  for  the 
:B|^|:  exchange  of  the  consolidated  company's  securities  for 

the  subsidary  companies*  securities.  This  financing  is 
not  sufficient,  however,  to  provide  for  the  needs  of  the 
new  corporation.     Working  capital,  to  a  considerable 


11 ' 


FORMING  CONSOLIDATIONS 


221 


amount,  must  certainly  be  obtained  or  the  new  corpora- 
tion will  plunge  at  once  into  banki-uptcy.  Further- 
more, a  consolidatio-  almost  always  implies  changes  in 
methods  of  operation.  New  officers  must  be  appointed, 
old  ones  dismissed.  Some  of  the  plants  perhaps  will  be 
dismantled  or  put  on  part  time;  other  plants  will  be 
remodeled  and  refitted  with  expensive  modem  machin- 
ery. Frequently  the  whole  arrangement  of  the  plants 
and  processes  of  manufacture  will  be  reformed  in  order 
to  introduce  the  methods  that  belong  to  large  scale 
production.  All  of  these  changes  may  be  necessary  in 
order  to  obtain  the  economies  that  belong  to  combina- 
tions. They  may  and  probably  will  prove  wise  and  in 
the  end  highly  profitable.  At  the  moment  of  forming 
the  consolidation,  however,  they  call  for  large  amounts 
of  new  capital  funds  and  bring  to  the  front  some  of  the 
most  difficult  problems  of  financing  which  a  promoter 
lias  to  face. 

113.  One  method  of  raising  cash. — Following  the 
basic  principles  outlined  in  Chapter  XII,  the  promoter 
of  a  small  consolidation  will  endeavor  to  raise  whatever 
cash  is  necessary  first  of  all  from  local  bankers  and 
financiers.  If  he  succeeds  in  obtaining  the  coopera- 
tion of  these  men,  he  is  much  more  likely  to  find  his 
proposition  regarded  favorably  by  larger  banking  in- 
terests. Two  courses  are  now  open  to  him;  either  he 
may  issue  bonds  of  the  new  company,  which  will  not  be 
first  mortgage,  but  which  he  may  name  "first  and 
refunding"  or  "first  general"  or  "first  consolidated";  or 
lie  may  try  to  sell  stock  in  addition  to  that  which  has 
been  given  to  the  owners  of  the  consolidated  plants. 
Either  course  has  its  disadvantages.  The  bond  issue 
probably  cannot  be  sold  on  advantageous  terms  because 
the  consolidation  must  necessarily  be  an  experiment  at 


t '  I 


eI 

'i 

pi 

.  1 

::  ■ 

:i 

m 

H 

^B 

1         . 

In 

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IB 

1 

11 

1 

IB 

IT'' 

222 


CORPORATION  FLXANCE 


the  beginning  and  even  its  best  securities  will  have  a 
speculative  character.  Furthermore,  in  many  cases  the 
promoter  will  find  the  property  of  the  subsidiary  com- 
panies already  mortgaged  so  that  the  bonds  of  the  con- 
solidated company,  whatever  title  he  may  pick  out  for 
them,  will  be  in  reality  junior  liens.  The  sale  of  stock 
is  undesirable  because  the  stock  issue  in  all  probability  is 
already  large;  it  has  to  be  large  in  order  to  make  the 
terms  offered  to  the  owners  of  the  subsidiary  plants 
sufficiently  attractive.  If  still  more  stock  is  issued  to 
be  sold  to  the  public,  it  will  be  very  difficult  to  pay 
dividends  even  on  the  preferred,  not  to  speak  of  the 
common.  This  result,  the  promoter  certainly  does  not 
desire.  He  has  promised  usually  heavy  cumulative 
dividends  at  once  on  the  preferred  stock  and  has  held 
out  hopes  of  early  dividends  on  the  common,  and  his 
reputation  is  staked  on  the  fulfillment  of  these  predic- 
tions. Moreover,  he  is  himself  usually  a  large  holder 
of  the  common  stock. 

On  balancing  these  considerations,  the  promoter 
usually  finds  himself  strongly  inclined  to  favor  the  sale 
of  bonds  if  they  can  be  sold  at  any  reasonable  price. 
His  sanguine  temperament — for  that  kind  of  tempera- 
ment naturally  belongs  to  a  promoter — leads  him  to 
minimize  the  danger  of  increasing  the  new  corporation's 
fixed  charges  and  to  exaggerate  the  probable  profits. 
He  therefore  turT».  to  local  bankers  for  assistance  in 
borrowing  tlic  necessary  funds.  Frequently,  as  the  first 
step,  he  has  the  corporation  put  out  a  bond  issue  under 
a  mortgage  of  the  limited  open-end  ty]»e.  The  pro- 
vision may  be.  and  often  is.  that  of  tlic  total  issue  one- 
half  shall  be  offered  for  sale  in  the  first  year,  one-fourth 
in  the  second,  and  one-fo\n*th  in  third  vear:  of  course, 
the  length  of  time  over  which  the  sale  is  spread  and  the 


FORMING  CONSOLIDATIONS 


223 


corporation's  allotment  each  year  may  vary  indefinitely, 
depending  on  the  urgency  of  the  company's  need  for 
cash.  He  then  obtains  a  guarantee  from  local  finan- 
ciers, including  perhaps  some  of  the  banks,  to  take  the 
unsold  bonds  at  the  end  of  each  period  from  the  corpora- 
tion at  a  low  price  which  is  specified.  By  this  guarantee 
the  corporation  is  protected  from  an  absolute  failure  to 
secure  cash.  The  guarantors  must,  of  course,  be  paid, 
usually  by  a  considerable  commission  on  all  the  bonds 
that  are  sold.  This  kind  of  arrangement,  which  we 
will  consider  at  greater  length  later,  is  known  as  under- 
writing. 

The  promoter  may  now  take  his  bond-issue— or  pa.t 
of  it,  if  he  has  been  able  to  get  the  sale  of  only  a 
part  guaranteed — to  a  friendly  bank  and  secure  a  short- 
time  loan,  using  the  bonds  as  collateral  security.  He 
lias  thus  provided  for  the  immediate  cash  necessities  of 
the  new  company  at  the  beginning  of  its  existence.  As 
fast  as  he  can  sell  the  be  ids,  he  pays  off  the  bank  loans 
and  thus  puts  the  corporation  in  a  stronger  financial 
position.  If  the  issue  is  entirely  successful,  the  corpo- 
ration will  soon  have  plenty  of  cash,  obtained  by  this 
bond  issue,  and  will  be  able  to  carry  out  the  improve- 
ments in  operation  which  are  expected  to  make  the 
consolidation  a  profitable  venture. 

The  essential  feature  of  this  plan,  it  will  be  noted,  is 
tlie  distribution  of  the  risk  among  several  different 
parties.  The  bank  is  well  protected  in  accepting  the 
bonds  as  collateral  by  the  guarantee  of  responsible 
parties  to  buy  the  bonds  nt  the  end  of  a  certain  period, 
if  no  purchaser  willing  to  pay  a  higher  price  is  pre- 
viously found.  The  guarantors  usually  take  little  risk, 
for  the  price  of  the  bonds  to  them  is  made  low  enough  to 


be  attractive.    The  corporntitm  obtains  at 


enou 
once 


what- 


224 


CORPORATION  FINANCE 


I 


ri 


if 


i 


ever  cash  is  necessary  and  its  only  risk  is  that  it  may 
have  to  sell  its  bonds  to  the  guarantors  at  a  low  price. 

Naturally  the  promoter  in  the  period  left  to  him 
before  the  guarantors'  option  becomes  effective  does  his 
best  to  sell  the  bonds  at  a  good  price.  The  methods 
which  he  uses  and  the  agencies  through  which  he  works 
are  fully  treated  in  later  chapters. 

114.  Problems  in  forming  a  large  consolidation.— 
There  is  no  difference  in  principle  between  the  pro- 
moter's functions  in  forming  a  small  and  his  functions 
in  forming  a  large  consolidation.  He  is  doing  things 
on  a  bigger  scale,  however,  and  finds  necessary  several 
important  variations  in  his  methods. 

In  the  first  place,  such  a  consolidation  is  almost  always 
too  large  to  be  handled  by  any  one  man.  In  order  to 
reach  all  the  parties  concerned  and  to  inspire  confidence, 
it  is  generally  desirable  for  several  promoters  to  work 
together,  each  performing  a  portion  of  the  labor. 
When  the  United  States  Steel  Corporation  was  formed, 
as  described  in  the  following  chapter,  almost  all  of  the 
prominent,  successful  promoters  of  the  country  were 
concerned  !n  one  way  or  another.  Apart  from  the 
necessity  of  dividing  the  work  to  be  performed,  it  is  very 
desirable  to  promote  harmony  and  secure  the  best  solu- 
tions of  the  difficult  and  complicated  problems  invob'ed 
in  such  a  consolidation  by  getting  the  ideas  of  a  con- 
siderable number  of  able  and  experienced  men. 

In  the  second  place,  the  promoter  or  group  of  pro- 
moters is  dealing  with  such  a  large  number  of  security 
owners  of  subsidiary  companies  that  lengthy  consulta- 
tion with  these  owners  and  bargain-making  is  out  of 
the  question.  TTsually  the  hea\'y  stockholders  in  the 
subsidiary  companies  are  consulted  and  frequently  they 
have  some  part  in  the  scheme  of  promotion.     The  great 


"N>? 


FORMING  CONSOLIDATIONS 


225 


mass  of  stockholders,  however,  are  simply  notified,  when 
the  proper  time  comes,  of  what  is  proposed  and  are  in- 
vited to  accept  the  oifer  which  the  promoters  lay  before 
them. 

115.  Basis  of  consolidation. — The  amount  and  char- 
acter of  the  security  issues  of  the  proposed  consolidation, 
and  the  terms  upon  which  these  securities  will  be 
exchanged  for  the  securities  of  the  subsidiary  companies, 
are  fixed  by  the  promoters  in  advance.  This  does  not 
mean  that  the  terms  are  unfair  to  the  subsidiary  com- 
panies' stockholders.  On  the  contrary,  ihey  are  usually 
extremely  liberal.  It  must  be  remembered  that  it  is 
very  desirable  for  the  holding  company  to  have  all  the 
stock — certainly  all  the  voting  stock — of  each  sub- 
sidiary. The  less  subsidiary  company  stock  there  is 
left  outstanding,  the  less  is  the  chance  of  complaint  and 
annoying  legal  processes  on  the  part  of  the  dissenting 
stockholders  against  the  actions  of  the  holding  company. 
The  promoters,  therefore,  try  to  oflPer  such  terms  that 
all,  or  almost  all,  the  stock  of  subsidiary  companies  will 
he  exchanged  for  stock  of  the  consolidation. 

The  usual  arrangement  is  to  divide  the  capital  stock 
(tf  the  consolidation  into  preferred  and  common,  the 
amount  of  the  preferred  being  equivalent  to  the  total 
market  value  of  all  the  subsidiary  company  stock. 
Practically  any  amount  of  common  stock  may  be 
issued;  the  promoter  usually  puts  out  as  much  as  he 
thinks  can  possibly  obtain  dividends  within  a  reasonable 
number  of  years.  The  stockholders  of  the  subsidiary 
companies  are  then  off'ered  somewhat  more  than  the 
market  value  of  their  stock  payable  in  cash,  or  consid- 
t  rably  more  than  its  market  value  payable  in  preferred 
stock.  If  they  take  preferred  stock,  they  will  ordinarily 
receive  in  addition  a  substantial  bonus  of  common  stock. 

C— VI— 18 


220 


CORPORATION  FINANCE 


11 


f: 


U 


The  first  proposition  is  intended  to  catch  the  ultra-con- 
servative; the  second  proposition  is  intended  to  be  even 
more  attractive.  The  stockholder  is  to  receive  in  place 
of  his  present  holding,  having  a  fluctuating  and  uncer- 
tain dividend,  a  more  than  equal  amount  of  stock 
preferred  as  to  dividends,  and  in  addition  a  considerable 
amount  of  the  new  common  stock.  Very  few  stock- 
holders are  likely  to  refuse  so  attractive  an  offer. 

The  application  of  these  principles  is  well  illustrated 
in  the  promotion  of  the  biggest  and  one  of  the  most 
successful  consolidations  that  has  yet  been  fon-ned, 
the  United  States  Steel  Corporation.  So  important  is 
this  great  company,  not  only  in  connection  with  our 
present  study  of  corporation  finance,  but  in  its  influ- 
ence on  industry  in  this  country,  that  it  has  been  I  bought 
best  to  devote  a  separate  chapter  to  a  review  of  its  origin, 
its  promotion,  its  financial  history  and  its  prospects. 

116.  The  Interhorough-MetropoUtan  Consolidation. 
— Another  typical  consolidation  which  was  formed  under 
very  different  conditions  is  the  I nterbo rough-Metropol- 
itan Company,  the  holding  company  for  the  transporta- 
tion companies  of  New  York  City.  A  chart  showing 
the  complicated  internal  organization  of  the  company 
has  been  presented  in  Chapter  VI.  The  terms  of  the 
consolidation  are  clearly  set  forth  in  the  following  ex- 
tract from  a  lecture  by  Albert  W.  Atwood,  Financial 
Editor  of  the  New  York  Press  and  Lecturer  on  Invest- 
ments in  New  York  University. 

1 .  Companies  Taken  Over. 

Metropolitan  Steel  Railway  $  52,000,000  stock 

Metropolitan  Securities  Co.  .'J0,000,000  ♦* 

Intcrborough  Rapid  Transit  Co.  ^5,000,000  " 


$117,000,000 


FORMlxNG  CONSOLIDATIONS 


227 


Capitalization  of  Inter-Met, 

Bonds 

Preferred  Stock 

Common  Stock 

Total 
Deduct 


$  70,000,000 

55,000,000 

100,000,000 

$225,000,000 
117,000,000 


Excess         $108,000,000 

3.  Basis  of  Exchange. 

Interborough  —  one  share  received  $200  bond  and  $99 
common  stock  in  the  Intcr-Mct. 

Metropolitan   Street  —  one   share   received   $100  pre- 
ferred and  $55  common  in  the  Inter-Met. 
Metropolitan  Securities  —  one  share,  $75  paid  up,  re- 
ceived $93.50  common  in  the  Inter-Met. 
The  Interborough-Metropolitan  took  over  practically  all  the 
capital  stock  of  the  subsidiary  companies.    In  1902  the  Metro- 
politan Street  Railway,  which  had  been  the  company  which  con- 
trolled and  operated  the  surface  lines,  ran  short  of  money  and  a 
scheme  was  devised  to  keep  it  going  by  leasing  it  to  the  New 
York  City  Railway  (which  had  a  comparatively  small  amount  of 
stock)  the  stock  of  which  was  in  turn  all  taken  over  by  the 
Metropolitan  Street  Railway  shareholders.    By  getting  a  large 
majority  of  the  stocks  of  the  Metropolitan  Street  Railway  and 
t!  0  Metropolitan  Securities  Company  the  Inter-lMetropolitan 
got  control  of  the  entire  surface  system  and  by  securing  the 
stock  of  the  Interborough  Rfti)id  Transit  it  got  control  of  the 
subway  and  elevated  lines.     The  total  of  securities  taken  over 
was  about  $117,000,000  and  the  new  company  issued  $225,000,- 
000  of  securities.    The  excess  capitalization  was  $10C,000,000, 
which  in  view  of  the  fact  that  many  believed  the  surface  lines 
«(re  already  waterlogged,  was  a  remarkable  piece  of  finance. 
Tlirce  reasons  are  advanced  for  the  excess  capitalization: 

1.  The  promoters  say  they  honestly  believed  that  within  two 
or  three  years  the  common  stock  would  be  earning  2  per  cent. 


228 


CORPORATION  FINANCE 


il^'i: 


h; 


2.  The  merger  was  formed  at  the  height  of  the  business  and 
financial  boom  of  1906  and  at  that  time  the  later  financial  and 
business  reaction  was  not  generally  foreseen. 

3.  The  holders  of  the  securities  of  the  old  companies  had  to 
have  an  inducement  to  exchange  their  securities  for  the  new  ones. 
In  other  words,  they  had  to  be  hypnotized  into  believing  that 
they  were  getting  something  for  nothing.  Much  was  made  of 
the  growth  of  the  passenger  trafBc  in  New  York  and  the  official 
prospectuses  declared  the  common  stock  of  the  new  combine 
would  certainly  be  able  to  pay  dividends  in  time  owing  to  the 
growth  of  population. 

These  two  illustrations  will  serve  to  indicate  the  gen- 
eral practice  in  exchanging  a  consolidated  company's 
securities  for  those  of  the  subsidiary  companies.  It 
may  be  observed  that  the  steel  consolidation  was  far 
more  conservative  than  was  the  Interborough-Metro- 
politan  consolidation.  The  second-named  company  was 
in  a  dangerous  situation  from  the  very  beginning, 
for  it  was  compelled  to  pay  regular  interest  on  its 
large  bond  issue  or  go  into  receiver's  hands.  The  steel 
corporation  gave  only  a  small  amount  of  bonds — rela- 
tWe  to  its  total  capitalization — and  consequently  was  not 
in  serious  danger  of  insolvency.  Even  if  it  had  failed 
to  pay  interest  on  its  preferred  stock  it  would  not  have 
been  forced  into  a  perilous  position.  The  Interborough- 
Metropolitan  financing  was  on  its  face  so  unsound  as  to 
arouse  the  suspicion  that  this  particular  consolidation 
was  never  intended  to  succeed. 

117.  Canada's  experience  in  forming  consolidationt. 
— Canada's  experience  in  industrial  consolidations  has 
been  confined  to  recent  years,  more  partictilarly  from 
1910  to  1918  inclusive.  Indeed,  it  has  been  a  new  factor 
in  corporation  financing  in  that  country  and  one  which 
has  not  proved  eminently  successful.     Generally  speak- 


1»V 


FORMING  CONSOLIDATIONS 


229 


ing,  the  features  of  the  movement  have  been  the  large 
number  of  consolidations,  the  heavy  capitalization 
(often  proving  to  be  over-capitalization)  and  the  conse- 
(juent  necessity  for  reorganization.  In  the  volume  on 
Investment  and  Speculation,"  figures  are  cited  showing 
that  the  number  of  industrial  mergers  negotiated  in  the 
Dominion  from  January,  1909,  to  January,  1913,  was 
56.  The  aggregate  authorized  capitalization  (includ- 
ing bonds)  of  these  mergers  was  $456,938,266.  The  56 
amalgamations  absorbed  248  individual  companies.  The 
aggregate  capitalization  of  206  of  these  individual  com- 
panies was  approximately  $167,289,182,  which  amount 
in  various  ways  was  increased  upon  amalgamation.  The 
40  securities  issued  to  the  public,  resulting  from  the 
amalgamation  movement,  totalled  $57,346,666.  With 
16  of  these,  amounting  to  $16,500,000,  an  aggregate 
bonus  of  $6,750,000  was  given.  The  largest  consolida- 
tion was  the  Canada  Cement  Company,  which  absorbed 
twelve  companies.  Its  authorized  capitalization,  in- 
cluding bonds,  amounted  to  $38,000,000. 

Amalgamation  operations  have  not  been  confined  to 
one  or  a  few  classes  of  commodities.  Companies  hand- 
ling soap,  cereals,  asbestos,  bread,  flour,  milk,  cars, 
leather,  lumber,  cement,  dried  fish,  carriages,  bolts  and 
nuts,  steel,  coal,  ice,  felts,  shoes,  furs,  crockery,  paint 
and  jewelry,  have  all  seen  apparent  or  real  gain  in  a 
combination  of  interests.  Arrangements  have  also  been 
made  between  navigation,  light  and  power,  brewery, 
canning,  retail  box  and  numerous  other  companies. 
These  instances  are  sufficient  to  exemplify  the  wide- 
spread nature  of  what  is  a  new  feature  in  Canadian 
commerce  and  finance. 

Among  the  objects  and  advantages  to  be  gained  by 
consolidation,  the  following  have  been  cited  by  promot- 
ers in  Canada: 


I 

I 

4 


230 


CORPORATION  FINANCE 


«s' 


The  standardization  of  brands. 

Elimination  of  needless  competition. 

Securing  of  further  working  capital. 

Prevention  of  increase  in  prices  to  the  public. 

Keeping  pace  with  the  growing  market  demand. 

Elimination  of  a  large  amount  of  freight  charges. 

Savings  from  the  concentration  of  the  executive  force. 

Economies  in  the  purchasing,  manufacturing  and  sell- 
ing departments. 

Ability  to  establish  branches  of  the  one  company  in 
various  parts  of  the  country. 

Specialization  of  various  plants,  dispensing  with  un- 
necessary duplication  of  output  and  patterns. 

Although,  naturally  enough,  the  fact  that  companies 
have  found  themselves  in  a  critical  condition,  is  not 
stated  by  promoters  as  a  reason  for  consolidation,  this 
was  probably  the  real  cause  in  some  cases.  Keen  com- 
petition, bad  financing  or  disaster  on  the  part  of  one 
company  might  be  met  to  some  extent  by  being  swal- 
lowed by  a  combine. 

118.  Basis  of  consolidation. — The  basis  of  consolida- 
tion is  one  of  the  most  important  considerations  for  the 
shareholders  of  the  companies  absorbed.  The  promot- 
ers of  amalgamations  in  Canada  have  given  little  infor- 
mation to  the  public  on  this  point.  Generally  speaking, 
the  companies  forming  the  merger  have  taken  bonds, 
preferred  or  common  stock  in  the  combine.  Supposedly, 
the  individual  companies  have  usually  desired  a  fairly 
large  holding  of  the  amalgamation's  bonds.  Preferred 
stock  has  sometimes  been  accepted  with,  in  some  cases, 
a  bonus  of  common  stock.  In  the  formation  of  these 
new  companies,  it  would  seem  that  comparatively  little 
cash  has  been  paid  by  the  consolidation  for  the  proper- 
ties of  individual  companies. 


FORMING  CONSOLIDATIONS 


881 


This  exchange  of  securities  might  possiblj  lead  to  un- 
due inflation  of  capitalization  including  the  bond  issue, 
l)ut  there  are  two  counteracting  influences:  first,  the 
companies  entering  the  trust  would  naturally  wish  to 
obtain  a  fairly  large  share  of  the  bond  issue,  which  ranks 
first  in  ^he  matter  of  interest  payments;  second,  if  the 
bond  issue  were  made  unreasonably  large  it  might  prove 
a  difficult  task  to  make  the  earnings  of  the  amalgama- 
tion sufficient  to  pay  the  interest  on  the  bonds.  The 
average  merger  bond  should  prove  a  safe  investment, 
although  in  Canada,  unfortunately,  it  has  not  always 
done  so,  owing  chiefly  to  over-capitalization. 

One  of  two  instances  of  the  basis  of  consolidation  may 
be  cited.  In  the  case  of  the  Steel  Company  of  Canada, 
the  various  concerns  included  agreed  to  accept  the  bonds 
of  the  amalgamation  for  two-thirds  of  the  appraised 
vahie  of  the  properties.  They  also  agreed  to  accept  pre- 
ferred stock  for  the  remaining  one-third  of  the  appraised 
value  plus  the  liquid  assets  of  the  properties,  and  com- 
mon stock  against  the  earning  capacity  as  demonstrated 
by  the  history  of  the  company. 

An  important  provision  is  that  by  which  the  company 
is  prevented  from  paying  dividends  on  its  common  stock 
until  such  time  as,  from  earnings  of  the  company,  there 
has  been  placed  in  the  treasury  a  sufficient  amount  to 
pay  dividends  on  the  preferred  stock  for  one  year  in 
advance. 

^Vhen  the  sale  of  the  Brantford  Screw  Company  to 
the  Canada  Bolt  and  Nut  Company  was  confirmed  by 
the  shareholders  of  the  former  concern,  the  following 
division  of  stock  was  agreed  upon:  holders  of  Brantford 
Screw  Company  preferred  were  to  receive  seven  per  cent 
cumulative  preferred  stock  in  the  Canada  Bolt  Com- 
pany, at  the  rate  of  $145  for  every  share,  and  in  addition, 


282 


CORPORATION  FINANCE 


II- 


a  bonus  of  thirty  per  cent  in  the  common  stock  of  the 
new  company.  Holders  of  the  Brantford  Screw  Com- 
pany common  stock  received  $120  in  new  T,ref erred  and 
thirty  per  cent  in  new  common. 

The  proceeds  realized  by  the  Canadian  Pacific  Lum- 
ber  Company,  Limited,  from  the  sale  in  July,  1911,  of 
$1,750,000  (approximately)  six  per  cent  first  mortgage 
bonds  to  bearer,  less  expenses,  were  to  be  applied  ex- 
clusively in  carrying  out  the  consolidation  of  the  five 
properties  in  which  it  became  interested.  The  proprie- 
tors relied  entirely  for  their  profit  on  their  holdings  of 
shares  in  the  company. 

Of  the  $3,650,000  six  per  cent  first  mortgage  and  col- 
lateral trust  bonds  of  the  Canadian  Steei  Foundries, 
Limited,  issued  in  March,  1911,  $2,900,000  (including 
a  public  oflFering  in  London  of  $2,000,000)  were  issued 
for  the  purchase  or  acquirement  of  control  and  for  the 
development  of  the  properties  of  the  Montreal  Steel 
Works,  Limited,  and  the  Ontario  Iron  and  Steel 
Company,  Limited.  The  sum  of  $750,000  was  re- 
tained by  the  trustee  for  retiring  a  similar  amount  of 
bonds  of  the  Montreal  Steel  Works,  Limited,  then  out- 
standing. 

119.  Dangers  of  over-capitalization.— Tae  capitaliza- 
tion, and,  in  that  connection,  the  issue  of  securities  to 
the  public,  is  perhaps  most  liable  to  abuse  by  self-in- 
terested promoters.  In  most  cases  the  aggregate  capi- 
tal of  the  mergers  is  in  excess  of  the  total  capitalization 
of  the  companies  absorbed.  Good  reasons  have  some- 
times been  advanced  to  account  for  that  fact,  but  this 
is  a  phase  of  the  amalgamation  movement,  conceming 
which  by  no  means  sufficient  information  has  been  given 
by  the  average  merger  promoter.  Making  allowance 
for  various  considerations,  the  capitalization  of  the  aver- 


FORMING  CONSOLIDATIONS 


23a 


age  consolidation  in  Canada  still  appears  to  be  larger 
than  that  of  the  total  capital  of  the  contributing  corpo- 
rations. 

After  allowing  for  money  required  for  extensions,  re- 
organization, new  factories,  and  the  like,  one  must  con- 
dude  that  a  proportion  of  the  securities  issued  by  the 
mergers  has  been  what  is  popularly  known  as  "watered 
stock."     Although  many  companies  have  not  issued  se- 
curities to  the  limit  of  authority  granted  them,  their 
power  to  place  bonds  and  stocks  upon  the  market  in  fu- 
ture may  extend  far  into  the  next  decade.     If  stock  and 
bond  issues  of  the  amalgamations  are  forced  into  domes- 
tic and  other  markets,  with  an  appetizer  in  the  shape  of 
a  bonus,  there  is  likelihood  of  protest  on  the  part  of  the 
public.     This  is  especially  so  in  the  London  market, 
where  the  securities  of  several  Canadian  mergers  have 
l)een  floated  and  are  likely  to  be  sold  in  the  future.    The 
investor  will  regard  favorably  the  stocks  and  bonds  of 
a  consolidation  conservatively  planned  and  financed 
without  an  ill-concealed  effort  to  market  practically  use- 
less and  valueless  securities.     Stock  watering  is  usually 
accomplished  with  ease,  but  the  public  are  becoming 
more  accustomed  tr  analyze  the  statements  of  new  com- 
])anies  and  to  invest  accordingly. 

As  has  been  stated  previously,  a  large  number  of  in- 
dustrial consolidations  in  Canada  have  had  to  undergo 
drastic  reorganization. 

120.  Bcorganhation  of  industrial  consolidations. — 
One  of  the  most  notable  breakdowns  of  recent  years 
among  the  consolidations  of  Canada  was  that  of  the 
Amalgamated  Asbestos  Corporation,  Limited,  in  1912. 

Action  was  taken  by  the  directors,  and  a  bondholders' 
committee  was  appointed  to  save  the  company  from  com- 

]ilete  disaster.    A  new  concern,  the  Asbestos  Corpora- 


21U 


CORPOKATIOX  FINANCE 


I 


} 


I 


tion  of  Canada,  was  formed,  and  the  old  company's 
properties  were  purchased.  The  capital  and  bonding 
powers  were  $7,000,000,  divided  as  follows:  First  mort- 
gage forty-year,  five  per  cent  bonds,  $3,000,000;  six  per 
cent  preferred  participating  stock,  $4,000,000;  common 
stock,  $3,000,000— total,  $10,000,000.  This  compared 
with  a  stock  and  bond  capitalization  of  $2,500,000  of 
the  old  company. 

In  submitting  their  reorganization  scheme,  the  bond- 
holders' committee  pointed  out  that  it  was  evident  from 
the  operation  of  the  company  that  the  original  capi- 
talization, involving  a  fixed  charge  of  $400,000,  was  ex- 
cessive. The  average  earnings  for  a  period  of  three  and 
a  half  years  were  not  less  than  $250,000,  and  under  nor- 
mal conditions  the  company  should  exceed  this.  The 
plan  of  reorganization  suggested  was  the  formation  of 
a  new  company,  with  a  capitalization  of  $5,000,000 
bonds,  of  which  $2,875,000  were  issued  at  the  outset, 
$4,000,000  of  six  per  cent  participating  preferred  stock, 
and  $2,875,000  common  stock.  Under  this  plan  the 
holder  of  $1,000  par  value  old  bonds  received  $250  new 
first-mortgage  l)onds,  $500  new  six  per  cent  preferred 
stock,  and  $250  new  common  stock.  To  provide  work- 
ing capital,  it  was  proposed  to  sell  $875,000  new  first 
mortgage  five  per  cent  bonds.  The  annual  statement 
for  1911  showed  that  the  profits  for  the  year  were  only 
$98,003,  against  a  bond  interest  of  $400,000,  unfavor- 
able conditions  in  the  trade,  and  the  unsatisfactory  re- 
sult of  certain  contracts  telling  heavily  against  the  com- 
pany. 

The  Black  Lake  Consolidated  Asbestos  Company  was 
another  Canadian  concern  which  encountered  financial 
difficulties,  and  was  reorganized  in  1912.  A  new  com- 
pany, the  Black  Lake  Asbestos  and  Chrome  Company, 


FORMING  CONSOLIDATIONS  'JSo 

Limited,  was  formed,  with  bonding  powers  and  ca  il    i- 
zation  as  follows: 

Six  per  cent  income  bonds  (to  be  issued  bond  for 

bond  to  holders  in  the  old  company) $1,250,000 

First  mortgage  6  per  cent  bonds   (to  be  held   in 

treasury)    250,000 

Preferred    stock    1.000,000 

Common  stock •   8>000,000 

$5,500,000 

The  capital  stock  and  bonds  of  the  old  company  were 
as  follows: 

Authorized         Issued 

Ijonds  $1,500,000     $1.2:^0,000 

Preferred  stock 1,000,000       1,000,000 

Common  stock 3,000.000       3,000,000 

$5,500,000     $5,230,000 

It  is  interesting  to  note  that  two  reorganizations  of 
Canadian  industrial  consolidations  resulted  in  wiping 
out  stock  and  bonds,  mostly  "water,"  aggregating  $19,- 
000,000. 

121.  Most  complicated  merger  in  Canada's  history. — 
One  of  the  most  important  and  far-reaching  consolida- 
tions during  recent  years,  in  Canada,  was  the  merging 
of  its  lake  steamship  companies. 

To  create  this  consolidation,  a  new  company  was 
formed  called  the  Canada  Transportation  Lines,  Lim- 
ited, the  authorized  capital  of  which  was  $25,000,000, 
divided  into  125,000  seven  per  cent  cumulative  prefer- 
ence shares  of  $100  each  and  125,000  ordinary  share?  of 
$100  each,  and  with  authority  to  issue  thirty-year  first 


'jm 


( 'ORPOIIATION  FINANCE 


mortgage  debenture  stock  of  $8,000,000  bearing  interest 
at  five  per  ce-^  Mi  power  to  increase  the  amount  of 
such  mortga^^  ^.eoenture  stock  from  time  to  time,  pro- 
vidmg  the  proceeds  were  used  for  the  purchase  of  new 
boats  or  other  property  necessary  for  the  company  to 
acquire,  and  on  terms  fully  set  forth  in  a  mortgage  trust 

The  new  company  will  eventually  acquire  as  going 
concerns,  including  all  their  assets,  good-will  and  profits 
for  the  current  year,  the  following  companies:  Richelieu 
anc  Ontario  Navigation  Company;  Inland  Lines,  Lim- 
ited; Northern  Navigation  Company,  Limited;  Niagara 
Navigation  Company,  Limited;  St.  Lawrence  River 
Steamboat  Company,  Limited;  Richelieu  and  Ontario 
Navigation  Company  of  U.  S.  A.;  Quebec  Steamship 
Company,  Limited;  Canada  Interlake  Line,  Limited- 
Ontario  and  Quebec  Navigation  Company,  Limited! 
Merchants  Montreal  Line;  S.  S.  Haddington,  and  the 
Ihoiisand  Island  Steamboat  Company,  Limited. 

The  assets  of  these  companies  were  appraised  and  the 
acrounts  audited.    The  appraisal  company's  reports  and 
auditors'  statement  were  open  to  the  inspection  of  the 
shareholders.     The  new  company  had  assets,  as  shown 
by  the  statement  of  the  appraisal  company,  of  $33,053,- 
r)38,  in  which  vessels  were  valued  at  $10,806,834;  real 
estate,  buildings  and  dock  properties  at  $5,450,267.99; 
$061,.531.04  cash  on  hand,  and  the  sum  of  $8,694,969.89 
represented  the  value  of  leases,  contracts  and  good-will 
acquired  by  the  company  and  covered  by  ordinary 
shares.    The  company  started  free  from  debt  over  and 
above  the  debenture  stock  issued  and  current  amounts. 
The  net  earnings  of  the  consolidated  companies  for  the 
year  ended   December  81,  1912,  were  $1,494,554.48. 
which  showed  a  margin  for  the  payment  of  interest  on 


FORMING  CONSOLIDATIONS 


237 


debenture  stock  and  interest  on  the  preferred  stock  with 
a  fair  amount  applicable  to  reserve  and  ordinary  stock. 

Allowing  for  the  new  tonnage  not  in  operation  in 
1912,  on  the  same  basis  as  earnings  on  similar  tonnage 
in  1912,  the  increase  in  net  earnings  over  the  previous 
year  from  that  source  alone  was  estimated  at  $263,000. 

Little  information  was  obtainable  as  to  the  terms  of 
exchange  for  shareholders  of  the  companies  entering  the 
consolidation.  According  to  Mr.  Jahies  Carruthers, 
president  of  the  Richelieu  and  Ontario  Navigation  Com- 
pany, one  of  tije  largest  entering  the  merger,  the  im- 
portant point  that  the  directors  had  to  consider  was 
whether,  in  their  opinion,  it  was  in  the  interests  of  the 
Richelieu  shareholders  to  sell  out  the  assets  and  under- 
takings of  that  company,  and  if  so,  whether  the  Riche- 
lieu shareholders  were,  in  their  opinion,  obtaining  a  fair 
share  of  the  stock  of  the  new  company  for  the  stock 
which  they  held. 

Severe  criticism  was  leveled  at  the  promoters  of  this 
navigation  consolidation  as  to  what  was  termed  "the  dis- 
appearance" of  eight  and  a  half  millions  of  common 
stock.  This  eight  and  a  half  millions  was  left  over  after 
the  purchase  of  the  Richelieu  and  Ontario  Navigation 
Company's  stock.  Following  this  purchase,  the  Cana- 
dian Transportation  Company  had  to  secure  control  of 
the  Interlake  IJne,  the  Quebec  Steamship  Company, 
the  Thousand  Island  Line  and  other  interests  which 
absorbed  in  the  neighborhood  of  four  and  a  half  millions 
of  the  eight  and  a  half  millions  stock  left  over.  This 
left  in  the  neighborhood  of  four  niilllion  dollars  to  be 
divided  between  the  Canadian  ]>romoters  of  the  merger 
and  the  English  houses  who  financed  the  project.  It 
is  said  that  the  Knglish  house  which  put  up  the  money 
exacted  sti^  terms  and  secured  the  major  part  of  the 


238 


CORPORATION   FLNANCE 


I 


'•    « 


t 


four  millions  of  common  stock.  This  left  but  a  little  over 
a  million  dollars  to  be  divided  between  the  Canadian  pro- 
moters and  interests  who  brought  about  the  consolida- 
tion which,  as  a  Montreal  critic  said,  "In  view  of  the 
magnitude  of  the  merger,  the  amount  of  time  they  de- 
voted to  it  and,  in  contrast  to  some  of  the  gratuities  other 
promoters  have  secured,  is  not  out  of  proportion." 

In  financing  the  merger,  it  was  planned  to  issue 
f 7,500,000  five  per  cent  debentures  which  would  retire 
all  outstanding  bond  issues  and  permit  of  but  one  secu- 
rity being  placed  on  the  market.  In  some  cases  it  was 
proposed  that  the  transfer  of  bonds  should  be  on  a  basis 
of  earning  power  whether  they  were  "seasoned"  or  not. 
Those  who  objected  to  an  exchange  of  bonds  would  iii 
all  probability  be  offered  a  cash  price  for  the  holdings. 

It  was  believed  by  the  promoters  to  be  in  the  interests 
of  the  water  transportation  companies  of  Canada  that 
they  should  get  English  capital  on  a  large  Fiale  inter- 
ested in  this  business  just  as  it  is  to-day  interested  in 
the  great  railroads  of  the  country.  The  only  way  this 
could  be  accomplished  successfully,  in  their  opinion,  was 
to  be  connected  with  a  new  company  large  enough  to 
command  the  interest  of  some  of  the  most  important 
financial  houses  in  London.  The  $2.5,000,000  author- 
ized capital  of  the  new  company  will  l)e  listed  on  the 
London  Stock  Exchange  and  a  substantial  portion  of 
the  preferred  stock  was  to  be  taken  at  par  by  strong 
financial  interests  in  London. 


x^ 


CHAPTER  XV 

THE  UNITED  STATES  STEEL  CORPORATION 

122.  Preparing  the  ground.~lS90  to  1900  is  an  im- 
portant decade  in  the  history  of  the  steel  business  of  the 
United  States.     Between  1890  and  1893  production  was 
vastly  increased,  while  the  demand  for  iron  and  steel 
products  practically  stood  still.     As  a  result,   prices 
were  declining  and  a  majority  of  the  steel  producers 
wore  in  a  precarious  situaJ.n  even  before  the  severe 
crisis  of  1893  began  its  work  of  destruction.     The  crisis 
Iiit  the  steel  makers  especially  hard,  and  wiped  out  many 
of  the  small  concerns.     In  the  five  years  of  depression 
that  followed,  individuals  and  partnerships  as  factors  in 
steel  production  almost  disappeared;  their  places  were 
taken  by  comparatively  large  and  strong  corporations. 
These  corporations  not  only  managed  to  live,  but  even  to 
thrive  in  a  waj%  because  they  were  able  to  buy  new  plants 
and  enlarge  old  ones  at  bargain  prices.     By  the  year 
1K98  in  all  branches  of  the  steel  industry,  including  bar 
iron,  rolled  iron,  steel  rails,  sheet  steel,  tin  plate,  wire 
and  other  more  highly  finished  products,  a  considerable 
number  of  fairly  efficient  and  well-managed  corpora- 
tions, which  had  grown  in  strength  during  the  depres- 
sion, were  prepared  to  handle  tlie  flood  of  new  business 
that  was  expected  to  come  with  the  revival  of  good  times. 
The  floml  came  and  with  it  such  a  rise  in  prices  and  a 
'It  luge  of  profits  as  would  have  seemed  inconceivable 
f"o  or  three  years  before.     Steel,  in  Andrew  Carnegie's 
picturesque  phrase,  is  either  "a  prince  or  a  pa»jper." 

280 


I 


24U 


CORPORATION  FINANCE 


H 


The  reason  is  that,  as  large  amounts  of  fixed  capital 
must  be  invested,  the  supply  of  steel  products  cannot 
easily  be  increased  or  decreased ;  whereas,  as  steel  is  not  a 
prime  necessity,  the  demand  ^uctuates  violently.  In 
other  words,  since  supply  and  demand  do  not  move  up 
and  down  together,  prices  and  profits  jump  from  one 
extreme  to  the  other  with  extraordinary  rapidity. 

123.  The  steel  consolidations  preceding  the  forma- 
tion of  the  United  States  Steel  Corp  ition. — In  1908, 
then,  American  steel  makers  had  reaoned  a  higher  level 
of  prosperity  than  ever  before  and  were  moving  rapidly 
upward ;  the  business  was  carried  on  by  a  comparatively 
few  fairly  strong  corporations  in  each  line;  at  the  same 
time,  public  interest  in  the  advantages  of  industrial  com- 
binations and  in  their  supposed  opportunities  for  great 
profits  was  keen  and  the  public  appetite  for  the  securi- 
ties of  such  combinations,  or  "trusts,"  had  ben  excited. 
Placing  these  three  factors  together,  we  see  why  the 
three  years  following,  1898-1901,  were  marked  by  a 
remarkable  series  of  steel  consolidations.  We  cannot 
take  time  here  to  tell  the  stories,  interesting  though  they 
would  be,  of  these  consolidations.  For  our  purpose  it 
will  be  enough  to  name  the  important  steel  companies  in 
existence  in  1000. 

1.  The  Federal  Steel  Company  was  formed  in  Sep- 
tember, 1908,  by  combining  the  Illinois  Steel  Company, 
the  Minnesota  Iron  Company,  and  the  Elgin,  Joliet  and 
FiBstem  Railroad.  Its  authorized  capital  was  $200,- 
000,000  of  which,  however,  only  .$99,700,000  was  ever 
issued. 

2.  The  American  Steel  &  Wire  Company  was  organ- 
ized by  John  W.  Gates  in  March,  1S98.  It  was  big 
enough  to  control  virtually  the  entire  production  of  wire 
goods.     Its  capital  was  $00,000,000. 


THE  UNITED  STATES  STEEL  CORPORATION       241 

3.  The  National  Tube  Company,  formed  in  Feb- 
ruary, 1899,  included  over  a  dozen  companies.  It  was 
the  largest  concern  of  its  kind  in  the  world  and  at  the 
time  the  third  largest  concern  in  the  iron  and  steel  busi- 
ness, being  surpassed  only  by  Carnegie  and  Krupps,  of 
Germany. 

4.  The  National  Steel  Company,  the  American  Steel 
IIoop  Company,  the  American  Sheet  Steel  Company 
and  the  American  Tin  Plate  Company  were  organized 
in  the  period  from  December,  1898,  to  March,  1900,  by 
Judge  W.  71.  Moore,  his  brother,  James  H.  Moore, 
Daniel  G.  Reid,  William  B.  Leeds,  and  others  who 
were  later  given  the  titles  "Moore  Party"  and  "Rock 
Island  Crowd."  Of  these  concerns  the  largest  was  the 
Tin  Plate  Company,  which  was  a  consolidation  of  forty 
companies,  embracing  about  95  per  cent  of  the  total 
output  of  tin  plate  in  the  United  States. 

.')  The  biggest  and  most  powerful  company  of  all. 

The  Carnegie  Company,  was  not  a  consolidation,  but  a 

prowth.     This  great  concern  had  been  built  up  by  the 

consistent  policy,  extending  over  many  years,  of  putting 

most  of  its  earnings  into  improvements,  instead  of  into 

dividends.     The  organizing  genius  of  Carnegie,  Frick, 

Pliipps,  and  their  co-workers,  had  made  its  body  of 

workingmen  the  most  efficient  and  its  enormous  plant 

the  most  economical  in  the  world.     Through  its  control 

of  the  II.  C.  Frick  Coke  Company,  the  Oliver  Mining 

Company,  the  Pittsburg  Steamship  Company  and  the 

Pittsburg,  Ressemer  &  I^ake  Erie  Railroad,  together 

with  its  fit.  .-year  contract  with  the  Rockefeller  iron, 

mining  and  transportation  companies,  its  supply  of  raw 

materials  at  low  cost  was  assured  for  many  years  to 

come. 

124.  A  condition  of  unstable  equilibrium. — In  one  of 
r— VI— ifl 


;>»■ 


242 


CORPORATION  FINANCE 


' 


the  most  brilliant  chapters  in  his  well-known  volume  on 
"Trust  Finance"  Professor  E.  S.  Meade  has  well  de- 
scribed the  conditions  in  the  steel  business  in  1900.    In- 
dustrially the  situation  might  be  said  to  be  one  of  un- 
stable equilibrium.     It  might  have  been  expected  that 
all  of  these  consolidations  would  have  been  content  to 
enjoy  the  prosperity,  which  was  being  showered  upon 
steel  makers,  and  would  have  desisted  from  intense  com- 
petition with  each  other.     Ordinarily  competitive  strife 
awakens  in  periods  when  business  is  stagnant  and  mills 
idle,  while  harmony  is  readily  secured  so  long  as  orders 
are  outrunning  production.     This  would,  in  fact,  have 
been  the  happy  situation  in  the  steel  trade  if  it  had  not 
been  for  the  appearance  of  a  powerful  new  factor,  the 
tendency    toward    integration.     "Integration"    is   the 
economist's  technical  word  for  the  control  by  one  concern 
of  the  whole  process  of  production  from  the  raw  material 
to  the  finished  product.  Ordinarily  the  manufacture  of 
any  finished  article,  say  a  tin  can,  is  carried  on  through 
several  stages,  and  at  each  stage  passes  from  one  group 
of  producers  to  another  group.     In  making  the  tin  can 
iron  ore  must  be  mined ;  the  miner  sells  his  ore  to  a  manu- 
facturer who  transforms  it  first  into  iron  and  next  into 
steel;  this  manufacturer  sells  his  product  to  a  manufac- 
turer of  sheet  steel,  who  in  turn  passes  it  on  to  the  manu- 
facturer of  tin  plate;  finally  the  can  manufacturer  buys 
the  tin  plate  and  forms  it  into  tin  cans.    At  each  stage 
of  siich  a  process  there  is  a  sale  of  the  partly  finished 
product  and  a  profit  is  taken  that  enters  into  the  final 
cost  of  production.     Under  the  pfdicy  of  integration, 
according  to  which  all  these  stages  are  combined  under 
the  control  of  one  great  mnnnfaeturing  concern,  a  two- 
fold advantage  is  gained;  first,  the  intermediate  profits 
arc  all  secured ;  second,  a  permanent,  dependable  supply 


THE  UNITED  STATES  STEEL  CORPORATION       243 

of  raw  materials  at  lowest  costs  is  assured.     This  second 
advantage  is  even  more  important  than  the  one  iirst 

named. 

The  Carnegie  Company  in  1900  up  to  a  certain  point 
was  an  integrated  company;  that  is,  it  controlled  great 
quantities  of  ore  and  coal,  owned  its  own  steamships  and 
raihoads  for  the  transportation  of  these  raw  materials 
to  its  Pittsburg  plants,  and  at  the  Pittsburg  plants 
turned  out  steel  rails  and  a  large  variety  of  half-finished 
products.  It  was  partly  for  this  reason  that  the  com- 
pany had  become  so  strong  and  prosperous.  Neverthe- 
less, it  was  by  no  means  wholly  independent,  for  its  chief 
customers  were  the  other  steel  companies  in  the  Pitts- 
burg district  which  purchased  its  steel  billets,  ingots, 
i)ars,  plates  and  slabs.  The  Federal  Steel  Company, 
also,  was  "integrated"  up  to  a  certain  point,  but  like  the 
Carnegie  Steel  Company  was  by  no  means  independent 
of  its  large  customers.  A  large  part  of  its  business 
consisted  in  furnishing  wire  rods  to  the  American  Steel 
and  Wire  Company  and  steel  billets  to  the  National 
Tube  and  the  American  Bridge  Companies.  The  Na- 
tional Steel  Company,  a  much  smaller  concern,  fur- 
nished part-finished  products  to  the  other  Moore  com- 
panies, the  American  Tin  Plate,  American  Sheet  Steel, 
and  American  Steel  Hoop. 

The  group  of  producers  of  finished  steel  products 
were  by  no  means  satisfied  with  their  position.  They 
desired  to  secure  the  advantage  of  integration  for  them- 
selves; particularly  they  were  anxious  to  free  themselves 
frojn  the  domination  of  the  concerns  on  which  they  were 
dependent  for  raw  materials.  Therefore,  all  of  these 
(oinpanies  in  1898, 1899  and  1900  were  planning  to  pur- 
cliase  ore  and  coal  lands,  to  get  control  of  transportation 
companies  and  to  construct  furnaces  and  mills  for  the 


^■t 


2U 


CORPORATION  FINANCE 


manufacture  of  part-finished  steel  products.  The 
American  Steel  and  Wire  Company  brought  two  thou- 
sand acres  of  Connellsville  coal  land  and  large  ore  prop- 
erties.  It  already  had  partially  under  its  control  a  fleet 
of  twelve  ore  steamers.  It  now  announced  its  intention 
to  build  large  steel  plants  at  Milwaukee  and  Pittsburg. 
The  National  Steel  Company  purchased  iron  mines  and 
coal  land  and  started  to  increase  its  furnace  capacity. 
The  National  Tube  Company  began  work  on  a  large 
steel  plant  at  Wheeling,  West  Virginia. 

The  completion  of  these  projects  meant  heavy  loss  to 
the  Carnegie  Company  and  the  Federal  Steel  Company. 
They  were  forced  to  fight  back.  The  Federal  Steel 
Company  threatened  to  build  wire  mills  unless  the 
American  Steel  and  Wire  Company  should  abandon  its 
proposed  ^lilwaukee  plant,  and  the  threat  for  the  time 
being  proved  effective.  The  Carnegie  Company  an- 
noimced  that  it  would  construct  a  large  tube  mill  at 
Conneaut,  Ohio,  and  let  it  be  understood  that  it  would 
not  hesitate  to  enter  into  active  competition  with  all  the 
producers  of  finished  goods.  There  was  no  doubt  in 
the  minds  of  those  who  knew  Andrew  Carnegie  but  that 
these  plans  would  actually  be  carried  out.  They  re- 
called that  "the  wild  Scotchman"  had  been  successful  in 
even  more  daring  schemes. 

The  situation  was  full  of  dangers.  The  prosperity 
of  the  steel  makers  could  not  continue  through  the  bitter 
competitive  war  that  seemed  to  be  in  prospect.  The 
officials  of  the  Carnegie  Company  apparently  were  not 
seriously  worried,  for  they  felt  confident  of  the  ability 
of  their  organization  to  finance  and  make  highly  profit- 
able in  the  end  whatever  new  construction  might  become 
necessary.  Tlie  officials  of  the  other  great  companies, 
however,  were  not  so  complacent.     All  of  the  large  con- 


Tin:  UxNITED  STATES  STEEL  CORPORATION       245 


solidations  were  capitalized,  as  we  shall  see,  up  to  the 
limit  of  their  earning  power,  and  their  stock  had  been 
sold  on  the  promise  of  large  and  regular  dividends. 
J\Iorcover,  large  amounts  of  the  stock  were  still  owned 
by  the  original  promoters  and  underwriters.  The  man- 
agQTs,  therefore,  were  far  from  eager  to  enter  into  a 
regime  of  severe  competition.  Under  these  conditions 
the  suggestion  that  an  immense  holding  company,  the 
greatest  trust  in  the  world,  be  formed  was  favorably 
received.  It  furnished  the  only  possible  peaceful  so- 
lution of  the  pend'ng  problems.  The  strongest  finan- 
cial houses,  as  well  as  the  largest  steel  companies,  were 
committed  in  advance  to  this  plan,  because  it  was  the 
only  means  of  protecting  them  from  severe  loss. 

125.  Method  of  promotion. — The  promotion  of  the 
United  States  Steel  Corporation  was  not,  for  the  reasons 
that  have  been  given,  an  especially  difficult  task.  The 
chief  obstacle  was  overcome  when  men  of  sufficient 
breadth,  imagination  and  ability  to  form  a  clear  con- 
ception of  what  was  to  be  done  had  been  found.  So 
stupendous  an  undertaking  could  only  be  carried  out 
by  the  giants  of  the  financial  the  industrial  and  the 
legal  worlds.  Fortunately  for  the  project,  the  right 
men  were  at  hand  and  were  interested  in  its  success; 
above  all,  the  active  support  of  Mr.  J.  P.  Morgan,  the 
most  forceful  personality  in  Wall  Street,  did  more  than 
anything  else  to  make  the  plan  practicable  and  ulti- 
mately successful. 

The  details  of  the  promotion  of  the  United  States 
Steel  Corporation  have  never  been  disclosed.  Long  in- 
vestigation was  not  as  necessary  as  in  most  promotions 
for  the  reason  that  the  promoters  were  familiar  at  first 
hand  with  the  concerns  to  be  consolidated.  The  plan 
at  first,  it  is  known,  was  to  combine  only  the  great  com- 


I'. 

i 


I 


246 


COHPORATIOX  FINANCE 


panies;  the  Carnegie  Steel  Company,  Federal  Steel 
Company  Xational  Tube  Company  and  the  American 
Steel  and  Wire  Company.  The  potential  competition 
however,  of  the  four  JMoore  companies  looked  so  threat' 
ening  that  they  also  were  brought  into  the  combination. 
Certain  other  large  companies,  such  as  :iie  Jones  and 
Laughl.n  Steel  Company,  of  Pittsburg,  were  ap- 
proached, but  no  terms  were  agreed  upon. 

The  United  States  Steel  Corporation  filed  its  certifi- 
cate  of  incorporation  in  Xew  Jorsey  on  February  23, 
1901,  showing  a  capitalization  of  .$3,000.  Under  its 
anriended  certificate  of  April  1,  1901,  however,  its  capi- 
talization was  changed  to  $1,100,000,000,  one-half 
common  and  one-half  preferred.  The  charter,  it  may 
be  noted,  gives  discretion  to  the  board  of  directors  to 
increase  its  capital  stock. 

126.  Prospectus  of  the  corporation.— In  the  light  of 
the  later  history  of  the  company  and  as  an  example  of 
scientific  prospectus-making,  some  extracts  from  the 
prospectus  issued  by  the  firm  of  J.  P.  Morgan  and 
Company  are  given  below.     The  reader  should  note 
how  carefully  each  positive  statement  is  qualified  and 
how  much  more  is  implied  as  to  prospective  profits  than 
is  actually  said.     Yet  the  prospectus  cannot  be  called 
misleading.     If  it  is  read  as  carefully  as  it  was  written, 
it  will  be  found  not  only  to  contain  technically  accurate 
statements    but  to  give  a  correct  impression  as  well. 
The  difficulty  comes  in  the  fact  that  comparatively  few 
persons  are  capable  of  giving  it  a  careful  reading.    The 
prospectus  also  contains  a  sufficient  account  for  our  pur- 
pose  of  the  basis  of  consolidation. 

A  syndicate,  comprising  leading  financial  interests  through- 
out the  United  States  and  Europe,  of  which  the  undersigned 


THE  UNITED  STATES  STEEL  CORPORATION       24T 

arc  managers,  has  been  formed  by  subscribers  to  the  amount 
of  $'iOO,000,000  ( including  among  such  subscribers  the  under- 
signed and  many  large  stockholders  of  the  several  companies), 
to  carry  out  the  arrangement  hereinafter  stated,  and  to  pro- 
vide the  sum  in  cash  and  the  financial  support  required  for 
that  purpose.  Such  syndicte,  through  the  undersigned,  has 
made  a  contract  with  the  United  States  Steel  Corporation 
under  which  the  latter  Is  to  issue  and  deliver  its  preferred 
stock,  and  its  common  stock,  and  its  5  per  cent  gold  bonds 
in  consideration  for  stocks  of  the  above-named  companies 
and  bonds  and  stock  of  the  Carnegie  Company  and  the  sum 
of  $25,000,000  in  cash. 

The  syndicate  has  already  arranged  for  the  acquisition  of 
substantially  all  the  bonds  and  stock  of  the  Carnegie  Com- 
pa->v,  including  Mr.  Carnegie's  holdings.  The  bonds  of  the 
United  States  Steel  Corporation  are  to  be  used  only  to 
acquire  bonds  and  60  per  cent  of  the  stock  of  the  Carnegie 
Company. 

The  syndicate  offers  for  each  $100  par  value  of  stock  of 
the  class  mentioned  below,  the  amount  set  opposite  thereto  in 
preferred  stock  or  common  stock  of  the  United  States  Steel 
Corporation  at  par: 


.,) 


Name  of  company  and 
class  of  stock. 


Amol'ntofnew  stock  to 
be    delivered    in    pab 

VALUE. 


Pheferked 
Stock 


Common 
Stock 


Federal  Steel  Company: 

Preferred  stock $1 10.00  

Common  stock 4.00        $107.60 

American   Steel   and   Wire   Company   of 
New  Jersey: 

Preferred  stock 117.60  

Common  stock 102.60 

National  Tube  Company: 

Preferred  stock 126.00  ...... 

Common  stock 8.80  126.00 


1 


ii 


248 


CORPOUA'j'lOA   FINANTK 


National  Steel  Company: 

Preferred  stock ,25.00 

Common  stock 

American  Tin  Plate  Comj)anj  : 

Preferred  stock ,25  00 

Common  stock '       20  00 

American  Steel  Hoop  Company : 

Preferred  stock ^o^^O 

Common  stock 

American  Sheet  Steel  Company : 

Preferred  stock '. ^^O.OO 

Common  stock 


125.00 


125.00 


100.00 


100.00 

^'^l"   'f '''''''  *"  *''^'  ''^'^t   f«"«*  companies  the  ^7^, 
amount  of  stocks  so  to  be  offered  was  arranged  with  the^ 
pa   stockholders  of  those  con.panies,  who  ha.^-  re^uestlh:!- 
tr,but,on  of  such  amount  an.ong  the  four  companies,  to  be 
made  m  the  percentage  above  stated. 

Statements  furnished  to  us  by  officers  of  the  several  com- 
pun.es  above  named  and  of  the  Carnegie  Company  show  thatthe 
aggregate  of  the  net  earnings  of  all  the  companls  for  the  cal- 
endar vear  1900  was  amply  sufficient  to  pay  d.vulends  on  b^^^ 

funds  and  maintenance  of  properties.  It  is  expected  that  by  the 
consummation  of  the  proposed  arrangement'the  n.  ...tr 
ar^  deductions  heretofore  made  on  account  of  expenditures 
for  ™Provements  will  be  avoide<l,  the  amount  of  earnings  ap- 
pl.ab  e  to  dividends  will  be  substantially  increased,  and  grea  er 
abihty  of  investment  will  be  assured,  without  necessarily  in- 
creasing the  prices  of  manufactured  products. 

A  1  shares  of  the  United  States  Steel  Corporation  deliverable 

o  or  for  account  of  the  syndicate,  which  shall  not  be  required 

for  the  acquisition  of  the  stock  of  the  Carnegie  Company  or  for 

delivery  to  depositors  under  ierms  of  this  circular,  are  to  be 

retained  by  and  to  belong  to  the  syndicate. 

no  comn ''°'''*-  *°  ;*"*?''"*  '^'  ^-  ^'°''««"  *  C°-  "«  to  receive 
no  compensation  for  their  services  as  syndicate  managers  be- 


THE  UNITED  STATES  STEEL  CORPORATION       249 


vond  a  share  in  any  sum  which  ultimately  may  be  realized  by 
tlic  syndicate^ 

J.  P.  Morgan  &  Co., 
Syndicate  Managers. 

127.  Profits  of  the  promoters. — The  sum  which  ulti- 
mately was  realized  by  the  syndicate  was  never  made 
public,  but  it  is  easy  to  figure  that  it  must  have  been  in 
neighborhood  of  $240,000,0000,  face  value,  of  common 
stock,  against  which  should  be  off -set  $2.5,000,000  cash 
I'lirnished  by  the  syndicate  and  the  expenses  of  promo- 
tion. Assuming  that  the  common  stock  was  sold  by  the 
syndicate  members  at  an  r.verage  price  of  thirty,  which 
is  probably  lower  than  the  actual  average,  we  have  gross 
profits  of  $72,000,000.  Deducting  the  $25,000,000  and 
assuming  expenses  to  have  been  $1,000,000,  we  have  left 
net  promoters'  and  underwriters'  profits  of  $46,000,000 
— a  huge  sum  and  yet  not  too  great,  considering  the 
risk  and  financial  power  and  ability  required  in  the 
unprecedented  undertaking. 

Tlie  provision  of  cash  by  the  syndicate  was  a  some- 
what unusual  method  of  meeting  this  part  of  the  finan- 
cial problem  involved  in  promoting  a  consolidation. 

128.  Capitalization  at  the  beginning. — It  is  worth 
rioting  that  the  $160,000,000  Carnegie  stock  obtained 
m  exchange  $98,000,000  preferred  stock,  $90,000,000 
common  stock  and  5j5l 44,000,000  bonds  of  the  Steel  Cor- 
poration. In  addition  $160,000,000  Carnegie  bonds  ob- 
tained an  equal  amount  of  United  States  Steel  collateral 
Itonds.  Thus  the  par  value  of  the  stocks  and  bonds 
given  to  Carnegie  Company  security  holders  was  nearly 
one-half  billion  dollars,  more  than  one-third  the  total 
capitalization  of  the  corporation.  The  aggregate  capi- 
talization of  the  other  seven  original  companies  was 
$4.57,000,000  and  the  par  value  of  Steel  stock  given  in 


t     ; 


i 


■ 

I 
If 


; 


ip 


I 


Af    i 


250  CORPORATION'  FINANCE 

exchange  was  $532,000,000,   an  increase  of  $75,000,000 

1  he  terms  of  exchange  were  so  liberal  that  98  per  cent 

of  the  stock  of  the  original  eight  companies  was  acquired. 

Shortly  afterwards  two  other  companies  were  taken 

in,  namely: 

1.  The  American  Bridge  Company  which  had  been 
formed  m  April.  1900.  This  company  had  absorbed 
twenty-six  separate  concerns  and  embraced  over  nine- 
tenths  of  the  bridge-building  interests  of  the  United 
otates. 

2.  The  Lake  Superior  Consolidated  Iron  Mines  Com- 
pany which  owned  and  operated  valuable  mines  in  the 
Mesaba  range  of  the  Lake  Superior  inm  region. 

Practically  all  the  securities  of  the  Lake  Superior 
Company  were  acquired  and  8.5  per  cent  of  the  stock  of 
the  American  Bridge  Company. 

The  capitalization  of  the  United  States  Steel  Corpc 
ration  at  the  end  of  the  first  year  was  as  follows: 

Capital  Stock.  Preferred ^   510.281.100.00 

Common 608,802,600.00 

Capital  Stock  of  Subsidiary  Cos..  outstand- 

IT  '«*«»■    in". 216,914.88 

o'tL^V^  808.767.000.00 

^'^''^^^»  66.997.826.00 

$1,879,668,840.88 

The  figures  following  will  give  some  idea  of  the 
enormous  extent  of  the  steel  corporation's  property  at 
the  begmmng:  218  different  plants  and  transportation 
companies:  41  mines;  nearly  1.000  miles  of  railroad;  a 
lake  fleet  of  1 12  vessels  which  constituted  one-third  total 
tonnage  of  Xorthcm  Lakes;  controlled  78  blast  fur- 
naces,  one-third  of  the  number  in  United  States;  owned 


THE  UNITED  STATES  STEEL  CORPORATION       251 

j7,()00  acres  of  coking  coal  land;  leased  50,000  acres 
Pocahontas  Coal  land,  VV.  Va.;  owned  considerable 
areas  of  steam  and  gas  coal  in  Illinois.  The  most  im- 
portant assets  of  all  were  the  ore  deposits  in  the  Lake 
Superior  region,  which  were  estimated  by  Mr.  Schwab 
at  750,000,000  tons. 

129.  Additions. — The  principal  additions  to  the  steel 
corporation  have  been: 

1— Shelby  Tube  Co 1901 

2— Union  Steel  Co 1902 

3— Holdings  of  Chemung  Iron  Co.,  Duluth 1903 

4— Properties  of  Clairton  Steel  Co 1904 

5 — Lease  of  Hill  Holdings  in  Lake  Superior  Region. .  .  .  1906 

C — Tennessee  Coal,  Iron  and  Railroad  Company 1907 

The  Shelby  Steel  Tube  Company  was  a  small  and 
ij:reatiy  over-capitalized  concern  which  was,  however,  the 
largest  maker  of  seamless  tubing  in  the  world. 

The  Union  Steel  Company  was  a  consolidation  of 
.se\  en  coke-mining,  sheet  steel,  tin  plate  and  steel  com- 
panies in  and  near  Sharon,  Penna. 

The  Chemung  Iron  Company  was  a  Detroit  concern 
Mhich  owned  a  large  and  important  block  of  Mesaba 
(ire  deposits. 

The  Clairton  Steel  Company  was  a  Pittsburg  concern 
wiiich  owned  a  large  plan^,  2,600  acres  of  coking  coal 
land,  20,000  acres  of  mineral  lands  in  the  Marquette 
Kange  and  considerable  railroad  and  limestone  proper- 
ties. 

On  April  15,  1907,  the  notable  lease  of  the  Hill  ore 
lands  was  ratified.  The  lease  providej  that  a  royalty  of 
M.Q5  per  gross  ton  for  ore  of  a  fixed  grade  was  to  be 
j)aid  in  1907  and  the  royalty  increased  C  4-10  cents  per 
ton  each  succeeding  year.     The  minimum  to  be  mined 


'*•'.-;.-,  .,\^':'1H 


2/52 


C'ORPOR ATIOX  FIXA SCK 


i, 


■1    ^ 

I 


and  sl,,i,,«d  was  750,000  tons  in  1007  and  was  to  in- 
crease  7.0,000  tons  per  year  nntil  it  reached  8,250,0^ 
tons.  Ihe  option  was  reserved,  however,  to  the  Sted 
Corporation  to  end  the  lease  in  1913,  and  in  1912  the  a> 
proaelung  termination  of  the  lease  was  announced. 

f^"m,'Z        '  'T'  u'  "-^P"™"""  ""luired  about 
¥30  000,000.  or  praefcally  all,  of  the  ontstandinR  e„„. 
mon  stoc'k  of  the  Tennessee  Coal,  Iron  and  Railro^ 
Conu»„y.     The  stoek  was  paid  for  at  the  rate  of  C- 
00*-<0  par  value  of  the  10-00  year  sinking  fund  5  per 
cent  bonds  of  the  steel  enrporation  for  $10,000  par"!^ 
Tennessee  common.    Many  readers  no  donht  will  recall 
the  crcumstances  surrounding  this  deal.    It  was  n,ade 
possibly  by  the  ability  of  the  Steel  Corporation  to  pu 
up  ready  cash  in  the  critical  time  of  the  October.  ,907 
crisis.    The  cash  was  used  to  buy  in  the  Steel  Corpora- 
1^™  s  own  bonds  with  which  to  pay  for  Tennessee  sLk. 
The  operation  thus  ha.I  a  double  effect  of  supplying 
cash  to  persons  who  needed  it  badly,  and  of  supplving 
a  security,  which  was  acceptable  as  collateral,  in  !« 
"f  the  unavailable  Tennessee  stock.     The  Tennc  s^ 
Company  owned  16  blast  furnaces,  4,?0,000  acres  of  coal, 
ore  and  limestone  and  tin.fer  lands,  large  develooed 
coal  mines  and  a  big  .steel  rail  mill  at  Kus^v,  Ilf' 

Besides  these  large  purchases  the  steel  corporation 
has  also  increased  its  holdings  by  building  o.It  of  its 

thoTbT  r  ^""^^'>-  "™  l-l""t-  M  Gary,  Indian., 
there  has  been  erected  a  large  modem  steel  rail  mill  .t 

m,    "'^'IT'T   ""'"  "■'"  '•^«'"'  ">-™«"""  in 

«hich  1.  «.1  acres  arc  devoted  to  the  plant.  The  emt 
was  nearly  $80,000,000.  This  new  pl„„t  w.,,  ealledX 
I..V  the  gr^at  increase  in  the  western  demand  f oT  t«l 


THE  UNITED  STATES  STEEL  CORPORATION      253 

130.  Financial  changes. — The  chief  event  in  the 
financial  history  of  the  Steel  Corporation  is  its  much 
discussed  preferred  stock  conversion  of  1902.  In  April 
of  that  year  the  management  issued  a  circular  to  stock 
holders  saying  that  $50,000,000  new  capital  was  needed, 
one-half  for  redemption  of  temporary  loans  incurred  by 
constituent  companies  and  one-half  for  improvements. 
The  plan  proposed  was  to  create  a  new  issue  of  $250,- 
000,000  5  per  cent  bonds,  of  which  $200,000,000  was  to 
he  exchanged,  dollar  for  dollar,  for  an  equal  amount  of 
preferred  stock  and  $50,000,000  was  to  be  sold  for  cash. 
Each  prci'erred  stockholder  was  offered  the  right  to  sub- 
scribe to  the  extent  of  one-half  his  holdings,  paying  40 
per  cent  in  stock  and  10  per  cent  in  cash,  or  to  the  extent 
of  40  per  cent  of  his  holdings,  paying  in  stock  alone. 
The  argument  urged  for  this  plan  was  that  the  $50,000,- 
000  would  be  raised  and  yet  an  annual  saving  in  the 
company's  charges  of  $1,500,000  would  be  effected. 
To  this  plan  99  8-10  per  cent  of  the  stock  voted  at  the 
annual  meeting  assented. 

The  plan  was  objectionable,  how  ever,  to  certain  stock- 
hohlers  for  the  obvious  reason  that  a  new  issue  was  cre- 
ated superior  to  their  own  security  without  any  corre- 
sponding enhancement  in  the  value  of  the  corporation's 
assets.  The  plan  was  further  ol)jectionable  in  that  the 
i>siie  was  to  be  underwritten  by  a  syndicate  which  in- 
chided  some  of  the  corporation's  directors.  The  syndi- 
cate agreed  to  take  enough  of  the  bonds  to  bring  the 
total  sale  up  to  $100,000,000.'  In  return  they  were  to 
have  the  privilege  of  subscribing  to  any  or  all  of  the 
Inrnds  not  taken  by  the  stockholders  and  they  were  to  get 
a  4  per  cent  commission  on  all  the  l)onds  sold  to  the 
stockhohc  rs  or  otherwise.     It  was  objected  that  under 

'  See  a  copy  of  the  agrr^mcnt  in  Chapter  ZIX. 


254 


COHPOKATION  FINANCE 


I 


this  a^^ment  tlie  syndicate  took  a  very  slight  risk  in 

000,000  worth  of  bonds  would  be  sold,  and  got  an  «. 
cess-ve  eomm.ss,o„.  The  objections  on  this  Lre  we« 
never  satisfactorily  answered. 

The  opponents  of  the  conversion  plan  secured  a  tern- 
porary  mjunetion  and  brought  suit  to  restrain  «,ed" 

th  turtTu"""'"*"'  °'"  ""  P'""-    '^'^  <'---  of 
the  court,  however,  were  in  favor  of  the  Steel  Corpora- 

t.on  management,  on  the  ground  that  no  fraud  wl 
shown  .„j  t,    t  a,^  g^^^j  ^^        st«.kWders 

had  approved  the  issue.     The  danger  of  disaster  to  tl« 
corporation,  on  account  of  its  great  increase  in  bond^ 

interest  on  these  smkmg  fund  .5's  must  lapse  for  two 

rius  provision  is  a  safeguard  to  the  corporation,  though, 

ll    "!i  'i  """'■^  ""'  ^  "'  «™'  ™'"^  ■'"  «  period  o 
prolonged  depression  like  that  from  1893  to  1897 

sary  f  r  the  corporation  to  ecnomi^e.    Several  mills 
were  dismantled  and  some  of  the  sub-executive  offi  " 
were  abolished.    It  Wcame  desirable  to  change  somewC 

908  t^L     -Tr"""  '."  ""'  -'P"™"""    In  Ma,;; 
908  the  original  Carnegie  Company  of  Pennsylvania, 
the  National  Steel  Company  and  the  American  Stee 

t  arnegie  Steel  Comnnpy  „f  x,,„  j„,  ,  , 

the  year  the  American  Sheet  Steel  Company  and  ,W 
•American  Tin  Plate  Company  were  combin^ed  as 
American  .Sheet  and  Tin  Plate  Company.    Earlv  the 
next  year  the  corporalio„-s  search  for  wi.lcr  markeis  M 

'.>|.ort  Company,  which  is  the  selling  agency  for  all 


THE  UNITED  STATES  STEEL  CORPORATION      255 


the  foreign  business  of  the  corporation.  The  direct  con- 
trol of  this  company  is  in  the  Federal  Steel  Company. 

I.'31.  Basis  of  capitalization. — Is  the  steel  corpora- 
tion over-capitalized;'  It  is  not  worth  while  to  rehash 
the  wordy  debate  on  this  question,  which  has  lasted  for 
several  years,  but  a  few  facts  ought  to  be  noted.  The 
a^roregate  capitalization  of  the  first  ten  companies  to 
tnter  the  corporation  was  approximately  $710,000,000. 
In  exchange  for  this  amount  of  stock  ♦^he  corporation 
issued  $868,000,000  stock  and  $1  U,000,000  bonds,  an 
iutrease  of  $302,000,000.  In  addition  the  promoters  of 
the  steel  corporation  received  for  their  services  some- 
thing over  $240,000,000  in  stock.  Even  though  we 
should  estimate  that  all  the  subsidiary  companies'  stock 
represented  tangible  assets,  therefore,  we  should  still 
have  to  conclude  that  $.)42,000,000  of  the  United  States 
Steel  capitalization  was  water  at  the  start. 

But  what  are  the  facts  as  to  the  capitalization  of  the 
original  companies?  Daniel  G.  Reid,  president  of  the 
American  Tin  Plate  Comi)any,  testified  before  the  In- 
dustrial Commission  that  of  the  $46,000,000  capitaliza- 
tion of  that  company,  $18,000,000  (preferred  stock) 
was  supposed  to  represent  the  value  of  the  property  and 
!^28,000,000  (common  stock)  represented  hopes  for  the 
future  and  the  pay  of  the  promoter.  It  is  well  known 
that  in  the  capitalization  of  the  National  Steel,  Ameri- 
can Steel  Hoop  and  American  Sheet  Steel  companies, 
;'ll  of  which  were  promoted  by  the  same  interests  as  the 
American  Tin  Plate  Company,  the  same  principle  was 

rnllowcd. 

Similarly.  ^Slr.  ,Tolin  W.  Gates  testified  that  of  the 
"-^0,000,000  cajjitalization  of  the  American  Steel  and 
\\'ire  Company,  $20,000,000  to  $30,000,000  was  water. 
Of  the  $100,000,000  capitalization  of  th(    Federal  Steel 


250  CORPORATION  FINANCE 

^nr$7ooOiH:!.  $4-^;000,000  represented  tangible  assets 
and  $10  000,000  cash  assets,  vvliile  the  rest  was  water 

.feJlnl        "'^"*'  ^'^  ^"""^h  *«  ''n^'cate  that  of  the 
$710,000,000  capitalization  of  the  original  companie^ 
large  share  stood  for  nothing  more  tangible  than  goU 
will  and    prospects."  ** 

The  suits  to  prevent  the  carrying  out  of  the  preferred 
stock  conversion  plan  of  1903  brought  out  some  inter- 
esting  statements.     One  affidavit,  by  an  engineer  who 
was  represented  as  an  expert,  said  that  the  plants  and 
properties  of  the  corporation  could  be  duplicated  for 
about  $200,000,000  and  that  the  total  assets,  including 
«^.od  will  and  organization,  were  not  worth  $500,000,- 
000.     Another  affidavit  stated  that  the  plants  of  the 
Carnegie  Company,  represented  44  per  cent  of  the  pro- 
duct.ve  capacity  of  the  steel  corporation  and  that  these 
plants  had  been  valued  on  March  12,  1900,  bv  the  part- 
ners of  the  Carnegie  Company  in  a  legal  proceeding  at 
$7.,000  000.     On    the   other* hand.    Mr.'chrrK 
Schwab    then  president  of  the  steel  corporation,  sub- 
mitted the  following  valuation: 

1-Iron-oro  Properties ^    700,000.000 

2--PIa„ts,  M.IIs,  Fixtures,  Equipments 800,000,000 

8-CoaI  and  coke  fields,  87,589  acres 100,000,000 

4-Tran,portat,on  properties 80,000.000 

5-BIast  Furnaces        

6-Natura    Gas  Fu-Ms   ^0.000,000 

I    rZ    r  ?°^''^''" *'000.000 

8~Cash  and  casl,  .,,et. 214,278,000 

$1,466,278,000 

There  is  not  such  a  great  difference  between  these 

wo  estimates  as  at  first  appears.     More  than  one-half 

the  assets,  as  given  by  Mr.  Schwab,  consist  of  ore  and 


THE  UNITED  STATES  STEEL  CORPORATION       257 

coal  land  in  which  he  included  unmined  ore  at  a  high 
value.  Beyond  question,  such  an  estimate  is  uncertain 
and  speculative.  Technical  progress  may  introduce  new 
methods  of  treating  ore  which  will  greatly  reduce  the 
value  of  this  large  buried  mass.  Besides,  Mr.  Schwab 
had  already  counted  the  value  of  this  ore  once  when  he 
based  his  estimate  of  the  value  of  the  plants  on  their 
low  cost  of  production  and,  as  a  factor  in  that  low  cost, 
counted  in  the  cheapness  with  which  they  could  secure 
raw  materials. 

In  what  has  been  said  it  has  been  assumed  that  the 
proper  way  to  value  a  property  is  to  arrive  at  the  prob- 
able cost  of  replacing  it.  But  there  is  another  method 
of  valuation  which  is  more  popular  among  business  men, 
and,  to  the  writer's  mind,  more  scientific.  This  method 
is  to  capitalize  earning  power.  The  profits  of  the  eight 
original  sub-companies  of  the  Steel  Corporation  in  1900 
were  $96,000,000.  The  record  of  the  Steel  Corporation 
in  the  first  seven  years  of  its  history  was  as  follows: 

Net  Earnings 

1^2 $188,808,000 

1903 109,171,000 

1^*  73,176,000 

1^5   119,787,000 

1906   156,624,000 

1907   160,965,000 

1908 91,267,000 

Average    $120,614,000 

Now  if  we  assume  that  10  per  cent  is  a  fair  rate  on 
money  invested  in  the  steel  business  and  capitalize  prof- 
its on  that  basis,  we  get  a  result  not  a  great  deal  below 
the  present  capital  izaticm. 
r—vi— ir 


'r. 


I 


258  CORPORATION  FINANCE 

Our  general  conclusion  on  this  point  must  be  some- 
thing like  this:  If  the  properties  of  the  Steel  Corpo- 
ration were  sold  under  the  hammer,  they  probably  would 
not  fetch  one-half  or  one-third  the  amount  at  which  the 
corporation  is  capitalized.  Even  if  we  take  into  con- 
sideration good  will,  organization,  financial  connections, 
and  so  on,  we  could  hardly  say  that  the  assets  equal  or 
nearly  equal  the  capitalization.  But,  if  we  base  our 
valuation  on  earnings,  not  assets,  we  can  safeb'  say  that 
the  over-capitalization  is  not  very  great. 

The  Steel  Corporation  is  earning  immense  sums  be- 
cause it  is  well  managed;  because  it  has  prestige;  because 
in  some  lines  it  has  almost  a  complete  monoply.  These 
things  are  not  tangible  assets,  but  they  are  sources  of 
income;  and  income,  according  to  ordinary  business  us- 
age may  properly  be  capitalized. 

Even  from  the  ultra-conservative  standpoint,  it  may 
be  said  that  the  Steel  Corporation  is  rapidly  "squeezing 
out  the  water"  for  it  has  made  it  its  policy  to  provide 
from  its  gross  income  for  depreciation  and  for  improve- 
ments. The  figures  following  show  that  about  $300,- 
000,000  have  thus  been  added  to  the  tangible  assets  of 
the  corporation  since  its  formation. 

Sinking  Funds,  subsidfarv  companies $     9,,367,412 

Sinking  Funds,  U.  S.  Steel  Bonds 25,624,410 

New  Construction 176,187,166 

Increase  in  surplus 82,223,107 


$293,352,095 


132.  Operating  pnlic/;.  A  carcfiil  study  of  the  op- 
erating policy  of  the  Steel  Corporation  belongs  else- 
were.  Our  attention  may  be  turned,  however,  to  a  few 
conspicuous  facts. 


THE  UNITED  STATES  STEEL  CORPORATION       259 


The  corporation's  relations  with  its  employes  have 
so  far  been  exceptionally  harmonious.  There  has  been 
110  strike  or  serious  trouble  of  any  kind.  At  the  end  of 
11)02  the  corporation  started  its  famous  profit-sharing 
plan  under  which  a  large  amount  of  preferred  stock  has 
been  sold  to  employees.  The  workers  are  divided  into 
six  classes,  according  to  salary,  and  each  class  is  allowed 
to  buy  a  certain  proportion  of  stock  each  year  at  a  fixed 
price.  The  prices  named  have  always  been  somewhat 
below  the  market  prices.  The  corporation  gives  a 
bonus  of  $5  for  each  share  which  is  held  for  five  years. 
The  result  has  been  to  give  a  considerable  number  of  the 
210,000  employees  a  lively  interest  in  the  success  of  the 
corporation,  and  to  bind  them  more  closely  to  the  man- 
ai,'ement.  The  scheme  has  proved  practicable  and  has 
l)cen  probably  of  great  benefit  in  maintaining  industrial 
peace. 

The  corporation  is,  of  course,  simply  a  holding  com- 
pany and  has  only  a  general  oversight  over  the  sub- 
eotnpanies.  Each  subsidiary  company  manages  its  own 
internal  affairs  and  buys  and  sells  from  and  even  com- 
petes with  other  sub-companies.  Cross  shipments,  how- 
ever, are  avoided  and  raw  materials  are  furnished  by 
ffnmon  agencies.  The  idea  is  to  stimulate  each  com- 
pany by  internal  competition  and  otherwise  to  the 
hi<,rj)est  pitch  of  efficiency.  The  operating  ratio  or  per 
cent  of  manufacturing  costs  to  gross  business  has  been 
\('ry  steady  with  a  slight  tendency  downward  since  1902. 
The  ratio  has  not  moved  up  very  high  in  periods  of  de- 
pression, which  is  considered  an  indication  of  econom- 
ical management. 

133.  Steel  securities. — The  securities  of  the  United 
States  Steel  Corporation  now  outstanding  are: 


■  * 


M 


I 


260  CORPORATIOX  FINANCE 

1-UiidcrIying  bonds *    leo  877  «"7 

2-Coll.  Tr.  Gold  5's.  1901 '   Iwlllm 

S-^'       "     Skg.  Fd.  5's,  1903 JS;5^ 

4     P    7°**^^?""^.' $    620,601,i^ 

4-Prefcrrc^  Stock   g^o.^si^joo 

5-Comn,on  Stock 608.302.500 

Total  Securities   $1,489,084,977 

The  underlying  bond  issues  are  too  numerous  and  too 
small  m  volume  to  be  worth  discussing  here.  Most  of 
them  are  secured  by  direct  first  mortgages  and  are  very 
closely  held.  ^ 

The  collateral  trust  gold  5's  of  1901,  due  AprU  1, 
1951,  are  secured  by  the  deposit  of  all  the  securities 
owned  by  the  corporation.  A  sinking  fund  of  $8,040,- 
000  per  year  is  used  to  purchase  bonds  obtainable  at  115 
or  less,  and  since  August  1, 1911,  has  been  applied  to  the 
redemption  of  the  bonds  drawn  by  lot.  Almost  all 
these  bonds  are  held,  it  is  understood,  by  Andrew  Car- 
negie and  are  not  on  the  market. 

A  more  interesting  issue  to  us  is  the  collateral  trust 
smkmg  fund  10-60  year  gold  5's  of  1903.  The  author- 
ized  issue  was  $250,000,000,  of  which  $200,000,000  was 
reserved  for  exchange  with  preferred  stock  under  the 
conversion  plan.  As  a  claim  on  the  assets,  these  bonds 
rank  next  to  the  5's  of  1901.  They  are  further  pro- 
tected by  a  sinking  fund  of  $1,010,000  per  annum  to  be 
used  imtil  1913  for  the  purchase  of  bonds  at  110  or  less 
and  after  1913  for  the  redemption  of  bonds,  drawn  by 
lot,  at  110.  This  last  named  feature  introduces  *a 
speculative  element  into  the  security  which  is  supposed 
to  enhance  its  value.  If  the  estimates  already  quoted  of 
the  asset  value  of  the  property  of  the  corporation  are 


Tl IK  UxNITED  STATES  STEEL  CORPORATION      261 

correct,  these  bonds  have  behind  them  chiefly  the  earning 
power  of  the  corporation. 

Tlie  preferred  stock  issue  is  7  per  cent  cumulative. 
Dividends  have  not  been  missed  since  the  formation  of 
the  corporation.  The  conunon  stock  drew  4  per  cent 
in  the  first  two  years;  1/^  per  cent  in  1903;  nothing  from 
that  date  till  1906;  ll/^  per  cent  in  1906;  2  per  cent 
until  1909,  when  4  per  cent  was  paid,  and  5  per  cent 
since  1909. 

Steel  has  been  a  prince  now  for  several  years.  Is  it 
likely  to  become  so  much  of  a  pauper  that  dividends  or 
even  interest  will  be  threatened  ?  There  can  be  no  doubt 
but  that  the  corporation  is  still  in  danger;  a  bad  slump 
or  even  insolvency  is  conceivable.  On  the  other  hand, 
there  are  at  least  two  good  reasons  for  believing  that 
the  danger  is  rapidly  lessening  and  in  a  few  years  will 
be  a  thing  of  the  past. 

One  of  these  reasons  is  that  the  physical  condition  of 
its  properties  is  excellent,  according  to  all  reports,  and 
is  being  constantly  improved.  We  hi  re  already  alluded 
to  the  large  appropriations  for  depreciation  and  for  bet- 
terments. It  is  estimated  that  following  the  completion 
of  the  Gary  plant,  the  capacity  of  the  corporation  was 
increased  about  75  per  cent;  yet  the  interest  charges  are 
practically  the  same  as  they  were  at  the  beginning.  In 
addition,  new  ore  deposits,  it  is  said,  of  a  value  of  $400,- 
000,000  have  been  located  on  the  lands  of  the  Steel 
corporation.  The  second  reason  is  that  the  demand  for 
steel  in  this  country  is  apparently  insatiable.  Steel  rail 
production  to-day  is  nearly  three  times  that  of  1881 ;  yet 
this  particular  kind  of  product  which  was  of  great  im- 
portance in  1881  is  now  only  a  fraction  of  the  entire 
steel  trade.  The  demand  for  structural  shapes  and  for 
machinery,  already  enormous,  is  just  beginning  to  grow. 


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VV: 


262 


CORPORATION  FINANCE 


To  get  an  idea  of  what  may  be  expected  in  the  next  ten 
or  twenty  years,  let  us  observe  the  per  capita  increase  in 
the  production  of  pig  iron  in  the  last  three  decades  as 
shown  !  elcw: 


1880  171  pounds 

1890  329       " 

1900  399       « 

1905  619       " 

1910  669       " 

If  the  steel  business,  then,  grows,  as  the  biggest  and 
most  farsighted  men  in  that  line  expect,  and  if  the  pres- 
ent policy  of  improving  and  enlarging  the  proper- 
ties contmues,  as  there  is  no  reason  to  doubt,  we  may 
safely  conclude  that  the  earnings  of  the  Steel  Corpora- 
tion will  become  very  much  larger  than  they  are  now. 
Of  course,  those  earnings  will  not  grow  continuously. 
The  steel  busmess  is  speculative  and  erratic  in  its  very 
nature  and  always  will  be,  so  long  as  periods  of  depres- 
sion and  of  prosperity  alternate.  Yet  the  enterprise  and 
efficiency  of  the  United  States  Steel  managers  seem  to 
be  almost  a  guarantee  that  at  the  worst  steel  earnings 
will  never  sink  so  low  that  interest  charges  cannot  be 
met;  it  is  reasonable  to  expect  that  they  will  never 
sink  so  low  that  preferred  dividends  cannot  be  met ;  and 
it  is  even  reasonable  to  hope  that  the  common  dividends 
will  always  be  maintained  at  or  above  their  present  level. 


"Svn' 


CHAPTER  XVI 

SELLING  SECURITIES— THE  PROSPECTUS 

134.  The  four  methods  of  selling  securities.— When- 
ever new  securities— whether  of  an  established  company, 
of  a  new  concern  or  of  a  reorganization— are  issued, 
these  are  four  possible  methods  of  disposing  of  them. 
The  first  method  is  by  an  inside  distribution  of  the  se- 
curities to  people  already  interested  in  the  business. 
This  method  we  have  already  considered.  In  the  case  of 
a  close  corporation  the  distribution  of  the  securities  is 
obviously  a  simple  matter  of  bargain-making  among  the 
few  people  involved.  In  the  case  of  a  consolidation 
the  distribution  to  insiders  is  carried  on  by  exchanging 
tlie  new  securities  for  old  securities  as  already  explained. 

The  second  method  is  to  work  through  the  Wall 
Street,  or  some  similar  market,  which  is  considered  in 
the  chapter  following. 

The  third  method  is  to  sell  them  to  the  public  through 
established  bond  or  brokerage  houses.  This  method  will 
he  discussed  both  in  this  chapter  and  under  the  head  of 

underwriting. 

The  fourth  method  is  by  direct  appeal  to  the  public 
throtigh  newspaper  and  magazine  advertising,  through 
circular  and  individual  letters  and  through  salesmen. 
In  a  great  many  corporations  the  promoter  finds  the 
first  three  methods  unavailable  and  is  forced  to  resort 
to  this  fourth  method.  This  is  particularly  true  of 
speculative  enterprises. 

The  principles  that  should  be  followed  in  the  presen- 

203 


264 


CORPORATION  FINANCE 


tation  and  selling  of  corporate  securities  direct  to  the 
public  are  not  different  from  the  principles  that  should 
be  followed  in  selling  other  articles.     These  principles 
are  treated  in  the  treatise  on  Selling  and  Buying  and 
need  not  be  reviewed  here.     Something  should  be  said, 
however,  about  the  document  in  which  the  leading  facts 
with  regard  to  the  securities  are  stated  and  the  pros- 
pects of  the  company  discussed,  namely,  the  prospectus. 
^  135.  General  characteristics  of  a  good  prospectus.— 
The  promoter's  prospectus  should  be,  and  with  success- 
ful flotations  usually  is  a  work  of  art.    A  good  prospec- 
tus will  appeal  to  a  large  number  of  people,  will  arouse 
their  interest,  will  hold  their  attention  from  beginning 
to  end,  and  will  engender  confidence.    A  poor  prospec- 
tus will  nullify  whatever  success  the  promoter  may  have 
had  in  stimulating  curiosity  on  the  part  of  the  prospec- 
tive buyers  of  his  securities. 

It  goes  without  saying  that  it  should  be  well  written 
and  attractively  printed.    In  this  respect  the  same  rules 
that  apply  to  other  selling  literature  should  be  followed. 
Naturally  the  prospectus  will  emphasize  the  strong 
features  and  minimize  the  weak  spots  of  the  business. 
The  promoter  must  take  care,  h(swever,  in  so  doing  that 
he  does  not  misstate  or  conceal   any  material  fact. 
Otherwise  he  may  be  held  liable  for  fraud,  or  at  least 
anyone  who  subscribes  to  the  corporation's  securities  on 
the  strength  of  the  prospectus  may  have  good  legal 
grounds  for  withdrawing  from  his  contract.    The  skill- 
ful prospectus  writer,  who  is  presenting  to  the  public 
securities  which  he  knows  to  be  highly  speculative  in 
character,  must  find  some  means  of  reconciling  these 
apparently  inconsistent  requirements.    He  must  pre- 
sent all  the  important  facts  and  yet  he  must  make  his 
prospectus   strong,   attractive  and  convincing.    Any 


)$>&V 


S1:LLING  securities— the  prospectus        265 

well-trained  writer  should  be  able  to  do  the  trick  if  he 
studies  his  proposition  carefully. 

Obviously  in  any  prospectus  the  strikingly  attractive 
features  of  the  enterprise  will  be  made  prominent  and 
much  will  be  said  about  them.  Perhaps  the  statements 
with  regard  to  them  will  be  printed  in  bold  face  or  other 
prominent  type,  so  as  to  catch  the  eye  of  the  reader  at 
once.  Statements  as  to  the  more  doubtful  and  risky 
features  of  the  enterprise  will  be  tucked  away  in  some 
obscure  comer.  Thus  the  law  will  be  satisfied  and  at 
the  same  time  it  will  take  a  very  careful,  intelligent 
reading  to  ascertain  from  the  prospectus  the  real  facts 

of  the  case. 

Another  means  of  avoiding  legal  objections  is  to 
make  sweeping  general  statements  without  making  the 
writer  or  any  other  definite  person  responsible  for  them. 
Such  phrases  as  "competent  judges  have  reported,"  or 
"after  expert  examination  we  believe,"  or  "witnesses 
who  have  seen  the  property  are  thoroughly  convinced," 
are  very  common  introductions  in  prospectuses.  The 
statements  in  themselves  may  be  untrue;  yet  by  using 
such  phrases  the  writer  may  succeed  in  divesting  himself 
of  any  personal  responsibility. 

Most  prospectuses,  as  any  reader  of  them  will  testify, 
are  so  vague,  that  what  the  writer  implies  assumes  a 
much  more  prominent  place  in  the  average  reader's  mind 
tlmn  what  he  actually  says.  In  a  recent  mining  pros- 
pectus, for  instance,  we  have  the  following  typical 
sentence:  "We  have  every  reason  to  believe  that  the 
corporation  will  have  assets  at  the  end  of  the  year  that 
will  astonisli  each  and  every  holder  of  the  stock,  and  it 
is  our  belief  that  claims,  titles  and  rights  cannot  be 
bought  outright  for  $1,000,000  or  more."  Notice  that 
this  sentence  does  not  contain  any  single  statement  of 


I 


266 


CORrORATIOX  FINANCE 


fact  to  which  the  prospectus-writer  could  be  bound  down. 

Another  hoary  trick  that  is  worked  over  and  over 
again  in  the  prospectuses  of  new  companies,  is  to  call 
attention  to  the  immense  profits  of  other  companies 
working  in  the  same  filed.  It  is  very  seldom  indeed  that 
a  copper-mining  prospectus  is  issued  that  does  not  call 
attention  in  big  type  to  the  profits  made  by  the  holders 
of  the  original  stock  of  Calumet  and  Hecla,  the  Copper 
Queen,  Anaconda,  and  other  classic  examples.  The 
reader  is  expected  to  infer  that  the  new  corporation  will 
have  a  similar  history. 

136.  A  typical  speculative  prospectus. — The  pros- 
pectus of  a  company  designed  to  own  and  publish  a 
magazine  is  given  in  part  below.  Tlie  reader  will  find 
in  these  few  paragraphs  illustrations  of  all  the  principles 
mentioned  above.  In  this  case,  although  the  magazine 
is  stated  to  have  been  in  existence  for  twenty-eight 
years,  not  one  word  is  said  as  to  its  record;  instead,  all 
the  emphasis  is  given  to  "prospects,"  "purpose"  and 
"possibilities." 

It  IS  a  medium  that  can  treat  any  subject  with  justice  to  it- 
self and  its  readers ;  therefore,  its  pulling  power  for  subscrip- 
tions, you  will  agree,  covers  possibly  a  greater  field  for  circula- 
tion, than  any  magazine  that  you  can  recall.  Its  field  of  expan- 
sion i^  simply  unlimited. 

From  an  advertising  standpoint,  I  might  say,  after  years  of 
experience,  I  do  not  know  of  a  publication  that  has  such  pros- 
pects for  money  making  as  The  Blank  Company. 

Being  a  practical  publisher,  it  is  my  purpose  to  put  The 
Blank  Company  in  the  place  it  should  enjoy,  and  in  order  to  do 
this,  I  have  deemed  it  wise  to  share  its  future  with  a  number  of 
my  friends,  and  am,  therefore,  organizing  a  company  capital- 
ized at  $50,000  for  the  immediate  expansion  of  The  Blank  Com- 
pany. Tlie  stock  is  secured  by  the  property,  the  name  and  the 
good  will,  which,  if  put  up  at  auction,  would  be  considered  a 


SIXLING  SECriUTIES-THE  PROSPECTUS        267 

bargain,  if  purchased  at  man>'  times  the  amount  of  the  com- 
pany's capitalization. 

*  If  you  have  looked  into  the  magazine  field,  you  will  know  that 
altliough  some  of  the  larger  magazines  are  capitalized  for  over 
a  half-million  dollars,  they  are  all  making  phenomenal  money 
for  their  early  investors.  The  general  magazine  field  I  consider 
pretty  well  covered,  but  a  magazine  of  the  unique  name  that  The 
Blank  Company  possesses,  can  be  expanded  and  developed  and 
larger  profits  made  from  it  than  any  other  publication  enjoys. 
To  illustrate  the  earning  power  of  magazines,  permit  me  to 
say  that  one  magazine  was  sold  some  time  ago  to  a  well-known 
newspaper  publisher  for  nearly  $700,000,  in  spite  of  the  fact 
that  at  that  time  it  had  a  circulation  of  only  250,000  and  a 
shrinking  in  its  advertising  patronage. 

Another  well-known  magazine,  whose  circulation  had  dropped 
down  below  50,000  and  had  practically  no  advertising,  declined 
an  offer  of  $10,000  for  its  name  and  good  will. 

I  will  recall  that  if  you  had  been  able  to  buy  a  thousand 
dollars  worth  of  Munsey's  stock,  on  the  ground  floor  basis  (that 
you  are  now  oflTered  in  The  Blank  Company)  for  your  invest- 
ment the  thousand  dollars  in  Munsey's  now  would  be  paying  you 
$10,000  to  $12,000  a  year  in  dividends. 

If  you  could  have  invested  only  $100  in  MutiseyX  your  hold- 
ings would  now  be  worth  from  ten  to  twelve  thousand  dollars 
and  would  be  paying  you  $1,000  to  $1,200  a  year  in  dividends ; 
a  larger  investment  would  have  made  you  wealthy. 

An  English  author,  who  ten  years  ago  obtained  $2,000  worth 
of  McClure's  Magazine  stock  in  exchange  for  a  manuscript,  sold 
his  holdings  recently  for  $20,000,  having  received  in  dividends 
during  that  time  the  round  sum  of  $14,000.  For  his  $2,000 
worth  of  manuscript  he  received  in  a  decade  $84,000  in  cash,  a 
profit  of  1,700  per  cent. 

Everybody's,  The  Ladies*  Hone  Journal  and  many  other 
magazines,  represent  wonderful  money-making  investments. 

The  same  opportunity  is  knocking  at  your  door  at  this  mo- 
men*.  The  Blank  Company  with  its  twenty-eight  years  of 
continuous  existence,  with  an  unlimited  alvertising  field  and  with 


268 


CORPORATION  FINANCE 


Ir 

I: 

*  ■ 


m 


a  subscription  list  that  can  be  increased  beyond  that  of  any 
other  publication  in  existence,  offers  you  a  rare  opportunity  in 
associating  yourself  with  an  enterprise  which  will  make  money 
for  its  stockholders  very  rapidly. 

If  you  want  to  go  in  with  me  in  developing  and  expanding 
The  Blank  Company,  I  will  offer  you  some  of  its  stock  at  its 
par  value,  $10  per  share.  This  opportunity,  however,  will  only 
remain  open  for  a  short  while.  Stock  can  be  purchased  on  a 
basis  of  3  per  cent  for  cash  with  subscription,  or  10  per  cent 
down  and  10  per  cent  per  month. 

137.  A  typical  investment  prospectus.— In  the  above 
remarks  we  have  had  in  mind  principally  the  pros- 
pectuses of  highly  speculative  companies.    We  need  not 
pass  judgment  here  on  the  legitimacy  of  the  methods 
that  are  used  by  such  companies  to  obtain  subscriptions 
for  their  stock.     It  is  certainly  improper  to  delude 
subscribers.     On  the  other  hand,  it  is  unquestionably 
proper  to  present  a  new  enterprise  in  a  favorable  light. 
Just  where  the  dividing  line  between  an  Jionestly  favor- 
able and  a  dishonestly  deceptive  presentation  comes  is  a 
question  which  every  promoter  must  settle  with  his  own 
conscience.     The  prospectuses  of  well-kno>vn,  entirely 
legitimate  investment  securities  often  go  to  the  other 
extreme.     They  present  merely  a  dry,  formal  statement 
of  the  facts  with  sometimes  a  tabulation  of  the  assets 
and  earnings  of  the  company  or  bald  figures  of  some 
other  kind. 

For  instance,  several  of  the  leading  banks  of  the 
world— including  Baring  Brothers  and  Company  of 
London,  Comptoir  National  d'Escompte  de  Paris, 
Credit  Lyonnais  of  Paris,  Deutsche  Bank  of  Berlin,  J. 
P.  Morgan  and  Company,  the  First  National  Bank  and 
the  National  City  Bank  of  New  York— co-operated  in 
issuing  on  March  1,  1909,  a  $50,000,000  5  per  cent 


SELLING  SECURITIES— THE  PROSPECTUS        269 

internal  gold  loan  of  the  Argentine  Government. 
Much  might  have  been  said  as  to  the  wealth,  high  stand- 
ing and  prospects  of  the  Argentine  Republic  and  as  to 
the  small  amount  of  the  loan  in  comparison  with  the 
great  resources  back  of  it.  The  bonds  were  sold  at  the 
price  of  99  per  cent  of  the  face  value,  thus  yielding  to 
the  purchaser  something  over  5  per  cent,  a  high  rate 
on  the  loans  of  a  government  of  good  standing.  We 
can  imagine,  taking  the  examples  that  have  been  given 
above  as  a  basis,  how  a  promoter  used  to  getting  up 
prospectuses  for  speculative  concerns  would  have 
reveled  in  the  opportunities  that  this  issue  would  have 
afforded  him,  how  he  would  have  enlarged  on  the 
Argentine  Republic's  reputation  and  prosperity,  how 
many  word  pictures  he  would  have  drawn  to  illustrate 
his  statements. 

The  prospectus  issued  by  the  great  banks  that  have 
been  named,  however,  compressed  a  description  of  the 
bonds,  a  statement  of  the  terms  on  which  they  would  be 
issued,  and  the  argument  on  behalf  of  the  bonds  into 
the  four  brief,  cold  paragraphs  that  follow: 

Provision  is  made  for  a  sinking  fund  of  1  per  cent.  By  the 
operation  of  this  sinking  fund  the  loan  will  be  paid  off  in 
t'i-rty-six  years  at  the  latest.  The  contract  with  the  Argentine 
Government  provides  that  said  fund  is  to  be  applied  half  yearly 
to  the  purchase  or  tender  of  bonds  at  or  under  par  or  by  draw- 
ings at  par  should  the  bonds  be  at  over  par.  The  first  operation 
of  the  sinking  fund  will  take  place  in  the  month  of  December, 
1909.  Drawn  bonds  will  be  payable  on  March  1st  or  Septem- 
ber 1st  following  the  date  of  the  drawing.  The  Government 
undertakes  not  to  increase  the  sinking  fund  or  to  redeem  the 
whole  of  the  loan  before  March  1st,  1914. 

We  reserve  to  ourselves  the  absolute  right  in  our  discretion 
\o  close  the  application  list  at  any  time  without  notice  and  to 


270 


CORPORATION  FINANCE 


reject  any  or  all  applications  and  also  to  allot  Smaller  amounts 
than  applied  for. 

All  applications  should  be  made  on  forms  which  may  be  ob- 
tained at  our  offices,  and  must  be  accompanied  by  a  deposit  of 
$50  per  bond. 

If  no  allotment  is  made,  the  deposit  will  be  returned  in  full, 
and  if  only  a  portion  of  the  amount  applied  for  be  allotted,  the 
balance  of  the  deposit  will  be  appropriated  towards  the  amount 
due  on  March  10th,  1909.  If  any  further  balance  remains, 
such  balance  will  be  returned.  In  case  of  failure  to  pay  the 
balance  of  the  subscription  when  due,  all  right  in  any  previous 
payment  will  vest  in  us  absolutely  without  accountability  there- 
for. 


Although  such  a  presentation  is  unattractive,  it  is 
frequently  effective.  The  coldness  and  dryness  carry 
with  them  the  sense  of  conservative  safety.  For  that 
reason,  a  statement  of  this  kind  is  sometimes  put  for- 
ward as  a  prospectus  of  what  is  in  reality  a  highly 
speculative  company;  and  this  trick  when  skillfu^y 
executed  has  been  known  to  succeed. 

138.  The  ideal  prospectus. — Even  in  the  most  formal 
prospectus,  however,  it  is  usually  well  to  use  untechnical 
expressions  and  to  present  facts  in  such  a  manner  that 
they  will  be  not  merely  significant,  but  interesting. 
Some  such  tendency  is  coming  into  evidence,  even  in 
the  presentations  of  strictly  investment  securities.  The 
number  of  people  who  are  possible  investors  in  such 
securities  is  constantly  increasing  and  the  amount  of 
such  securities  is  also  increasing.  In  order  to  create  a 
market  for  these  immense  issues  among  people  who  are 
not  familiar  with  the  technical  jargon  of  the  financial 
world,  it  is  necessary  to  change  somewhat  the  old- 
fashioned  formal  method  of  presentation.  This  change 
is  undoubtedly  for  the  better.    As  the  intelligent  in- 


SELLING  SECURITIES— THE  PROSPECTUS        271 

terest  of  the  public  in  financial  affairs  grows,  we  may 
expect  to  see  the  typical  prospectus  of  a  speculative 
corporation  and  the  presentation  of  a  strictly  investment 
security  approaching  each  other  more  closely  in  tone  and 

in  form. 

Athough  in  this  country  the  prospectus,  as  has  been 
indicated,  is  so  frequently  used  to  present  speculative 
and  even  swindling  schemes  in  a  false  light  that  pros- 
pectus-writing has  come  to  be  regarded  almost  as  a 
dishonorable  method  of  securing  money  for  an  enter- 
prise, and  although  this  opinion  is  not  without  basis,  yet 
it  must  be  borne  in  mind,  on  the  other  hand,  that  there 
are  such  things  as  a  legitimate  direct  appeal  to  the  public 
for  funds  and  an  honest  prospectus. 

In  England  this  method  of  raising  funds  is  much 
more  generally  used  for  reputable  enterprises  than  in 
this  coimtry.  To  take  one  instance,  it  is  said  that  the 
English  Eastman  Kodak  Company  was  floated  with- 
out any  assistance  whatever  from  bankers  or  under- 
writers. About  $5,000,000  of  stock  was  sold  to  the 
public  through  direct  newspaper  advertising,  circulariz- 
ing and  the  issue  of  an  attractive  prospectus.  That  the 
method  in  this  instance  has  been  entirely  successful  is 
shown  by  the  fact  that  the  company's  stock  is  now  sell- 
ing at  the  rate  of  about  $675  a  share.  It  is  to  be  re- 
gretted that  the  number  of  similar  instances  in  this 
country  is  so  small. 

139.  Selling  through  havUng  houses.— The  securities 
of  almost  ali  large  legitimate  corporations  are  sold 
through  banks  and  brokerage  houses.  The  advantage  of 
this  method  to  the  investor  is  that  he  is  protected  more 
or  less  by  the  investigation  and  experienced  judgment  of 
his  banker.  The  disadvantages  are  three:  first,  on  ac- 
count of  his  leaving  the  investigation  to  the  banker  he 


272 


CORPORATION  FINANCE 


i  i 


i 


i  ! 


It  f  '■ 


m 


does  not  acquire  that  first-hand  knowledge  of  the  enter- 
prise in  which  he  invests  that  it  would  be  desirable  for 
him  to  obtain;  second,  that  he  is  thus  left  practically 
at  the  mercy  of  his  banker;  third,  that  the  broker's  com- 
mission, which  is  often  not  inconsiderable,  intervenes 
between  the  buyer  of  the  security  and  the  selling  corpo- 
ration. 

The  advantage  to  the  corporation  of  selling  through 
a  bank  or  brokerage  house  is  that  the  corporation 
officials  may  feel  certain  that  the  issue  will  be  success- 
fully disposed  of  in  this  way,  especially  if  it  is  "under- 
written," as  explained  in  Chapter  XVIII.  With  a 
corporation  of  any  size,  the  bond  or  brokerage  house 
will  probably  be  one  of  the  large  concerns  that  carry 
on  their  work  in  the  Wall  Street  district  of  New  York, 
the  State  Street  district  of  Boston,  the  La  Salle  Street 
district  of  Chicago,  or  the  corresponding  financial  center 
of  some  other  large  city. 

140.  Requirements  of  reputable  ba./'ing  houses.^ 
The  good  Wall  Street  houses  will  not  undertake  to  float 
issues  of  small  size — certainly  none  less  than  $100,000 
and  preferably  not  that  small — for  two  reasons;  first, 
because  there  is  not  enough  profit  in  selling  small  issues 
to  pay  for  the  expenses;  second,  because  a  small  issue  of 
stocks  or  bonds  never  becomes  well-known  to  the  public 
and  is  therefore  not  readily  marketable.  As  to  the  kinds 
of  enterprises  that  will  be  taken  up,  the  better  houses 
prefer  in  the  order  named,  steam  railroads,  electric  rail- 
roads and  industrials.  Most  of  them  will  not  touch 
mines,  oil  companies,  or  any  other  highly  speculative 
enterprise.  Tht  only  practicable  means  for  getting 
funds  for  such  an  enterprise  from  the  public  ordinarily 
is  by  direct  solicitation. 

There  are  not  many  high-class  Wall  Street  houses 


SELLING  SECURITIES— THE  PROSPECTUS        278 


ti.f^agcd  in  selling  securiti  md  there  are  a  considerable 
number  of  imitation  banking  houses  whose  main  object 
is  to  get  their  hands  on  the  money  of  "suckers."  The 
working  plan  of  such  swindlers  is  to  receive  persons  who 
come  to  them  with  securities  to  sell,  no  matter  how 
worthless  the  securities  may  be,  with  open  arms,  wax 
entliusiastic  over  the  market  for  the  securities,  make 
numerous  high-sounding  promises  as  to  the  sales  which 
they  will  be  able  to  make,  and  in  conclusion  demand 
from  the  victim  as  his  "guarantee  of  good  faith"  a  sum 
of  money  for  expenses.  Of  course  this  money  is  not 
honestly  spent.  The  high-grade  banking  houses,  on  the 
contrary,  will  receive  any  new  proposition  that  is  pre- 
sented to  them,  especially  if  it  comes  from  a  stranger, 
witli  skepticism ;  and,  if  they  show  any  interest  at  all,  it  is 
to  be  expected  that  they  will  make  a  long  and  thorough 
investigation,  before  committing  themselves  in  any 
manner.  It  is  poor  policy  to  approach  one  of  these 
houses  without  having  a  business  introduction  of  some 
kind.  Generally  speaking,  it  is  well  to  present  the 
proposition  in  writing  in  the  first  place,  giving  a  clear 
and  complete  statement  with  all  the  supporting  evidence 
that  can  be  added.  A  Wall  Street  banker  of  the  class 
that  the  writer  has  in  mind  is  not  likely  to  be  carried 
off  his  feet  by  persuasive  personal  eloquence  and  is  more 
hkely  to  yield  to  cold  figures  than  to  impassioned 
appeals. 

It  takes  a  man  who  has  spent  a  lifetime  in  the  Street 
to  tell  absolutely  what  are  the  sound,  reliable  houses  and 
what  are  the  more  or  less  shady  concerns.  There  are 
Wall  Street  firms  which,  to  the  writer's  knowledge,  are 
rc/yarded  by  Wall  Street  bankers  as  worse  than  banditti, 
which  nevertheless  have  kept  in  existence  and  have 
apparently  been  prosperous  for  many  years.  Such 
r— VI— 18 


274 


CORPORATION  FINANCE 


firms  may  maintam  expensive  suites  of  offices,  may  have 
pious-looking  personages  at  their  head  and  may  give 
an  appearance  of  permanence  and  honesty.  The  only 
sure  sign  of  their  general  unreliability,  that  the  writer 
can  give,  is  that  thej^  are  out  looking  for  business,  that 
they  make  an  effort  to  secure  for  themselves  the  flota- 
tion of  securities  of  small  corporations  and  that  they  are 
willing  to  pretend  to  sell  such  securities  without  having 
first  made  an  adequate  investigation.  Even  this  symp- 
tom, however  is  not  always  present,  for  the  heads  of  such 
concerns  are  shrewd  and  experienced  enough  to  make  a 
pretense  at  times  of  conducting  an  investigation  before 
they  accept  the  proposition  that  has  been  presented  to 
them. 

The  first  step  in  the  investigation  of  an  enterprise 
by  a  reputable  house  will  be  to  get  the  complete  record 
of  all  the  men  who  have  any  connection  with  it.  If 
there  is  a  flaw  in  the  reputation  of  any  of  them,  the 
whole  proposition  will  probably  be  dropped.  Next,  the 
prospects  of  the  enterprise  itself  will  be  looked  into. 
Every  large  house  engaged  in  selling  securities  keeps 
on  its  own  staff  capable  men  who  are  qualified  to  form 
an  expert  judgment  as  to  the  merits  of  the  common 
forms  of  business  enterprises,  such  as  street  railroads, 
manufacturing  plants,  and  so  on.  In  addition,  unless 
the  house  is  absolutely  satisfied,  it  will  probably  obtain 
reports  based  on  searching  examinations  by  three  classes 
of  professional  experts,  namely,  engineers,  lawyers  and 
accountants.  If  all  of  these  are  favorable,  from  begin- 
ning to  end,  the  proposition  will  perhaps  be  accepted. 

The  three  essential  factors  in  making  a  proposition 
acceptable  are: 

(1)  Good  reputation  of  the  men  connected  with  the 
enterprise. 


SELLING  SECURITIES— THE  PROSPECTUS        275 

(•2)  Absence  of  risky  factors  in  the  general  nature  of 
the  business  or  in  the  general  situation.  For  instance,  a 
street  railway  company  would  not  be  taken  up  if  the 
pci>ple  of  the  locality  in  whicli  it  had  been  located  were 
for  some  reason  bitterly  hostile  to  public  service  corpo- 
rations. In  the  same  way,  as  has  been  said,  the  good 
banking  houses  will  not  deal  in  the  securities  of  unde- 
veloped mines,  no  matter  how  promising. 

(3)  Practical  certainty  of  profits  sufficient  to  meet 
all  fixed  charges.  This  almost  goes  without  saying; 
yet  it  is  worth  noting,  because  many  people  seem  to  im- 
agine that  if  a  new  corporation  promises  to  have  consid- 
erable profits  its  securities  are  safe  investments.  It  is 
necessary  that  these  profits  should  not  only  be  large  in 
the  aggregate,  but  should  be  steady  enough  and  certain 
enough  to  guarantee  that  the  corporation  will  never  be 
compelled  to  pass  any  of  its  interest  payments  or  other 
fixed  charges. 

141.  2'heir  methods  of  selling  securities. — The  good 
Wall  Street  houses  are  so  exceedingly  careful  in  their 
investigations  because  they  sell  most  of  the  securities 
they  handle,  not  to  the  public  at  large  through  adver- 
tising and  through  wide  distribution  of  prospectuses, 
but  to  a  comparatively  small  number  of  their  clients. 
These  clients  include  not  only  indivduals,  some  of  whom 
have  regular  sums  to  invest  every  year,  but  also  such 
institutions  as  insurance  companies,  saving  banks  and 
trust  companies.  It  is  necessary  in  order  to  hold  this 
clientele  that  the  house  should  establish  and  maintain 
a  reputation  for  the  strictest  integrity  and  conservatism. 
So  long  as  this  reputation  is  maintained  there  is  seldom 
any  difficulty  in  selling  whatever  securities  the  house 
may  accept.     The  following  extract  from  an  article  in 


PI 


276 


CORPORATION  FINANCE 


the  "Bond  Buyers'  Dictionary"  gives  further  details  as 
to  the  methods  of  such  houses. 

It  is  throu^  the  retail  bond  dealers  that  the  great  investing 
public  of  the  country  is  reached.  The  other  day  a  retired  mer- 
chant died  in  Pittsburgh  whose  wealth  was  estimated  by  bankers 
to  exceed  $50,000,000.  Of  the  several  million  persons  who  read 
of  his  death  in  the  newspaper  the  following  morning  only  a 
few  had  ever  heard  his  name  before.  There  are  thousands  of 
similar  capitalists  in  the  United  States,  each  possessing  a  for- 
tune greater  than  was  owned  by  any  single  individual  in  the 
country  fifty  years  ago,  whose  names  are  entirely  unknown  to 
the  average  newspaper  readcn  There  are  several  hundred 
thousand  others  who  possess  independent  fortunes.  It  is  with 
these  individual  investors  that  the  retail  bond  merchant  deals. 
All  have  a  large  list  of  wealthy  customers,  to  which  they  are 
continually  adding.  The  customers  of  some  are  mostly  in  New 
York  or  Pennsylvania,  of  others  in  New  England,  of  other  in 
Canada,  of  others  in  the  West  or  the  South.  Some  have  wealthy 
foreign  customers. 

The  number  of  regular  customers  may  range  from  5,000 
to  as  high  as  25,000.  There  is  one  retail  bond  house  in  Wall 
Street,  which  has  been  in  business  for  seventy-five  years,  that 
has  a  list  which  could  not  be  purchased  for  several  million  dol- 
lars. It  includes  22,000  names,  and  these  customers  purchase, 
on  an  average,  nearly  $5,000  of  bonds  a  year  apiece,  or  a  total 
of  more  than  $100,000,000  a  year.  This  house  would  not 
hesitate  to  purchase  a  block  of  $5,000,000  or  $10,000,00  or 
even  $20,000,000,  of  municipal,  county,  or  railroad  bonds, 
knowing  that  it  would  be  able  to  dispose  of  the  entire  block  in 
the  course  of  a  few  months  in  small  lots  to  its  regular  customers. 

Practically  every  large  retail  bond  house  in  Wall  Street  now 
employes  salesmen,  who  travel  over  the  country  selling  bonds, 
very  much  as  drummers  sell  tea  or  coffee.  Some  of  the  largest 
houses  employ  as  many  as  forty  salesmen ;  aUogether,  more  th»n 
800  are  employed  in  Wall  Street.  Each  has  his  own  territory 
and  possesses  his  own  customers.    Many  make  salaries  of  from 


SELLING  SECURITIES— THE  PROSPECTUS        277 

$10,000  to  $15,000  a  year,  and  some  even  more.  All  arc,  to 
some  extent,  experts  on  values.  In  addition  to  employing  sales- 
men the  retail  bond  houses  advertise  extensively. 

The  reputation  of  a  bond  house,  and  the  following  which  it 
possesses  of  the  customers  of  a  bond  house  purchase  securities 
from  it,  not  because  of  personal  and  expert  knowledge  of  the  se- 
curity and  safety  of  the  bonds,  but  because  of  the  reputation 
of  the  house.  The  average  investor  whether  he  invests  $5,000 
or  $500,000  a  year,  after  a  superficial  examination,  purchases 
securities  almost  entirely  on  the  recommendation  of  his  bond 
dealer.  The  enormous  profits  the  bond  dealers  make  is  the 
price  they  charge  for  lending  this  credit  to  corporations  and 
municipalities.  Practically  every  one  of  the  leading  Wall 
Street  bond  houses  may  boast  that  no  investor  has  necessarily 
ever  lost  a  single  dollar  through  the  purchase  of  bonds  on  their 
recommendation.  With  such  a  record,  is  it  any  wonder  that, 
when  such  a  bond  house  offers  a  block  of  bonds  for  sale,  accom- 
panied by  a  recommendation,  that  the  entire  issue  is  often  over- 
subscribed within  twenty-four  hours  of  the  opening  of  the 
books? 


The  profit  of  the  banking  hou*^  ^  may  take  one  of  two 
forms,  either  a  commission  on  the  sales  or  the  difference 
between  the  price  at  which  it  buys  the  securities  and  the 
price  at  which  it  sells  them.  Commission  is  more  com- 
mon and  is  regarded  as  more  profitable.  The  amount 
of  commission  depends  altogether  on  the  size  and  repu- 
tation of  the  issue,  and  no  definite  statement  on  this 
point  can  well  be  made. 

The  question  frequently  comes  before  such  a  house, 
Do  you  absolutely  guarantee  the  securities  that  you 
offer  to  be  safe  investments?  Invariably  the  answer  is: 
No,  we  give  you  freely  the  benefit  of  our  experience  and 
of  our  best  judgment,  but  whatever  risk  is  involved  is 
yours,  not  ours;  we  guarantee  nothing.    Nevertheless, 


278 


CORPORATION  FINANCE 


it  is  a  well-known  fact  that  almost  all  houses  of  the  best 
character  will  protect  their  customers  in  case  of  loss  or 
risk.  In  the  first  place,  the  house  does  not  lose  interest 
in  the  security  as  soon  as  the  issue  has  been  sold.  It 
watches  the  future  career  of  the  issuing  corporation 
with  the  closest  attention  and  frequently  exerts  strong 
influence  toward  a  conservative  management  of  the  cor- 
poration. If  in  spite  of  all  its  care  and  its  efforts,  the 
security  depreciates  i?  alue,  as  will  happen  once  in  a 
long  time,  the  house  w'a  probably  offer  to  buy  it  back 
from  its  customers  at  the  sellmg  price.  This  is  not  laid 
down  as  an  infallible  rule,  but  as  a  custom.  Of  course, 
the  house  does  not  feel  bound  to  follow  that  course  un- 
less it  has  very  strongly  recommended  the  security  in 
the  first  place.  Its  motive  in  making  the  ofFer  is  simply 
to  maintain  its  hard-won  reputation  for  fair  dealing. 


.f 


CHAPTER  XVII 

SELLING  CANADIAN  SECURITIES 

142.  Markets  for  Canadian  corporation  securities. — 
The  methods  of  sale  of  corporation  securities  in  Canada, 
in  their  broad  principles,  are  similar  to  those  in  the 
United  States,  described  in  foregoing  pages.  Generally 
speaking.  Great  Britain  is  relied  upon  to  purchase  the 
majority  of  these  securities,  Canada  a  few,  while  the 
United  States  supplies  but  little  capital.  These  facts 
are  shown  in  the  following  tables.  The  first  shows  the 
volume  of  bonds,  also  the  share  of  corporation  bonds  of 
Canadian  companies,  for  each  of  the  eight  years  ended 
December,  1912: 

CANADIAN  COBPOHATION  BOND  SALES,  1905-1912 

Year  Corporation  Bond  Sales  Total  Bond  Sales 

1905  $125,497,284  $184,874,581 

1906 85,694,000  58,987,008 

1907  58,981,200  82,685,740 

1908  72,297,000  196,856,521 

1909  182,482,500  265,158,252 

1910  140,251,900  281,000,590 

1911  218,978,700  266,812,988 

1912  146,728,820  280,782,982 

Total   $925,810,904  $1,461,608,612 

The  various  proportions  of  the  Canadian  bond  sales, 
for  the  same  years,  taken  by  the  United  States,  Canada 
and  Great  Britain  are  shown  in  the  following  table: 

279 


I 


I  I 


i  I 


280 


CORPORATION  FIXAXCE 


f*  ; 


^1 


PEECENTAGE  SHARES  OF   CANADIAN   BOND  SALES,   1905-1912 

Year  United  States  Canada  Great  Britain 

1905   6.86  26.06  67  07 

1906   7.62  43.16  49  20 

1907   5.78  17.86  76.35 

1908   3.21  12.52  84.26 

1909   3.90  23.50  74  00 

1910   1.50  17.00  81.50 

1911    6.58  16.86  76.56 

1912   11.91  16.96  72.13 

143.  Canadian  prospectus  and  British  investor.—ln 
drafting  a  prospectus  for  the  British  market,  those  re- 
sponsible for  the  sale  of  Canadian  corporation  securities 
must  always  bear  in  mind  the  conservative  attitude  and 
the  demand  for  full  information,  of  the  British  investor. 
The  history  of  the  company  must  be  given,  and  details 
of  past  earnings,  estimates  of  future  earnings,  details 
of  assets,  and  so  on.  No  tricks  should  be  played  in  the 
prospectus.  The  facts  should  be  given.  Otherwise,  if 
trouble  should  come  later,  the  faith  of  the  investor  in  the 
veracity  and  honesty  of  the  promoters  will  disappear, 
which  is  not  helpful,  especially  if  further  issues  are  to  be 
made.  It  should  be  remembered  that  the  maintenance 
of  Canadian  credit  is  important  to  every  borrower.  Sir 
Frederick  Taylor,  manager  of  the  Bank  of  Montreal  in 
London,  expresses  this  very  clearly.  Writing  in  a  Cana- 
dian financial  paper,  he  says: 

It  must  be  obvious  to  everyone  with  any  knowledge  of  the 
subject,  or  who  gives  the  matter  intelligent  consideration,  that 
interruption— let  alone  stoppage— of  the  flow  of  capital  from 
England  into  Canada  would  instantaneously  check  the  develop- 
ment of  the  Dominion,  with  results  bordering  on  the  disastrous. 

It  18  not  uncommon  to  hear  certain  of  our  countrymen,  who 
should  know  better,  speaking  lightly— sometimes  almost  defiant- 


SELLING  CANADIAN  SECURITIES 


281 


ly — of  securing  money  in  New  York  or  Paris  if  London  is  not 
prepared  to  lend  what  is  required.  The  answer  to  these  unwise 
and  inexperienced  individuals  is :  "Try  Paris,  try  Wall  Street, 
and  see  what  the  result  will  be." 

Money  will  be  forthcoming  from  the  United  States  and  else- 
where in  ever-increasing  volume  for  private  enterprise  in  our 
country,  so  long  as  we  continue  to  prosper,  but  it  is  to  the 
London  market  that  the  Dominion  and  Provincial  Governments, 
tlie  great  transportation  companies,  the  large  cities,  etc.,  must 
come  for  money.  If  London  discontinued,  or  even  curtailed, 
the  supply  of  funds  to  Canada,  it  would  be  for  some  good  rea- 
son— a  reason  which  would  apply  equally  in  the  case  of  other 
money  centres.  But  as  a  matter  of  fact,  even  to-day  when 
our  credit  in  London  is  high,  it  is  rubbish  to  talk  of  Canada 
financing  her  requirements  to  any  material  extent  in  Paris  or 
in  New  York;  while  if  our  credits  were  injured  in  London,  it 
would  be  practically  impossible  to  get  money  in  either  of  the 
other  two  places. 

Notwithstanding  the  fact  that  the  progress  and  develop- 
ment of  the  Dominion  of  Canada  have  reached  a  stage  which 
has  aroused  the  wonder  of  the  civilized  world,  Canadians  are 
united  in  the  belief  that  the  development  of  their  country  is  still 
in  its  initial  stage,  and  therefore  this  motto  should  hang  upon 
the  walls  of  every  office,  business  house  and  financial  institution 
in  Canada :  The  maintenance  of  our  credit  in  London  is  vital. 

The  large  difference  between  the  exports  and  imports 
of  Canada  causes  that  country  to  send  many  securities 
to  the  London  market.  If  too  many  securities  were 
offered  it  would  mean  that  Canada  was  importing  too 
many  goods  or  exporting  too  little,  or  both.  Doubtless 
some  Canadian  securities  have  been  offered  which  should 
not  have  been  issued,  and  the  country's  imports  have 
been  unwisely  increased  by  the  extravagance  of  a  pros- 
perous people,  but  the  main  cause  each  year  is  the  same. 
As  one  of  the  leading  financial  authorities  has  said,  Can- 


282 


CORPORATION  FINANCE 


ada  needs  more  than  ever  new  mileage  of  railways,  vast 
quantities  of  new  rolling  stock,  warehouse  and  port  facil- 
ities, municipal  expenditures  in  hundreds  of  new  towns, 
and  an  enlarged  scale  of  improvements  in  all  the  older 
municipalities,  the  building  of  ordinary  roads,  bridges, 
and  other  conveniences,  in  many  new  areas  of  settlement! 
the  creation  of  plants  for  new  industries  and  the  general 
mcrease  of  existing  plants  throughout  all  Canada,  the 
erection  of  private  dwellings  in  greater  numbers  and  of 
more  permanent  construction  than  in  the  past,  and  many 
other  forms  of  betterment  which  need  not  be  detailed. 

144.  A  typical  Canadian  prospectus.— We  may  ex- 
amine the  typical  prospectus  of  a  Canadian  corporation 
issue  m  London— that  of  $2,100,000  seven  per  cent  cu- 
mulative participating  preferred  shares  of  $100  each, 
of  the  A.  Macdonald  Company,  Limited.     This  pros- 
pectus gives  details  of  capital,  authorized  and  issued; 
terms  of  payment  for  the  stock;  history  of  the  com- 
pany; list  of  its  branches,  particulars  of  assets,  earn- 
ings, profits;  certificates  of  chartered  accountants  and 
appraisal  companies;  names  and  occupations  of  the  di- 
rectors, information  as  to  how  the  proceeds  of  the  issue 
will  be  applied.    Indeed,  almost  all  that  is  necessary  for 
the  investor  to  judge  of  the  value  of  the  offering  is  given 
in  the  prospectus.     This  is  as  it  sliould  be. 

A  lengthy  letter  from  the  company's  general  man- 
ager, with  considerable  information,  is  included.  It  is 
written  in  a  conservative  tone,  as  the  following  extract 
will  show: 

The  business  of  the  A.  Macdonald  Company  was  founded 
more  than  twenty  years  ago  by  Mr.  Alexander  Macdonald,  who, 
prior  to  that  time,  had  conducted  a  retail  grocery  store  in  the 
city  of  Winnipeg.  Mr.  Macdonald  originated  the  idea  of 
founding  a  wholesale  grocery  business  on  the  mail  order  plan. 


SELLING  CANADIAN  SECURITIES 


283 


Instead  of  sending  travellers  on  the  road  to  visit  the  retail 
trade,  he  inaugurated  the  publication  of  a  price  list  or  cat- 
alogue, twice  a  month,  which  was  mailed  to  all  retailers.  The 
{•oiiipany's  price  lists  were  accompanied  by  order  forms  and 
envelopes,  so  that  all  the  retailer  had  to  do  was  to  write  his 
order  and  mail  it  to  the  company. 

Gradually,  as  the  business  grew,  branches  were  opened  at 
various  points,  the  original  warehouse  in  Winnipeg  becoming 
!lie  head  office  of  the  company.  As  the  branches  grew  in  num- 
ber the  demand  for  the  price  list  also  increased,  until  at  the 
present  time  there  is  probably  not  a  retail  grocer  in  the  terri- 
tory covered  who  does  not  regularly  receive  this  price  list. 

Satisfied  with  moderate  profits,  and  able,  through  this  es- 
tablishment of  branches,  to  deliver  goods  promptly,  the  Mac- 
(jonald  Company  has  built  up  an  enormous  business  in  North- 
ern Ontario  and  in  the  Provinces  of  Manitoba,  Saskatchewan 
and  Alberta.  So  great  has  been  its  success  that  the  entire 
stock  of  merchandise  has  been  turned  over  at  the  rate  of  nearly 
ten  times  per  annum. 

145.  Growing  United  States  market  for  Canadian 
securities. — While  the  bulk  of  Canadian  corporation 
bonds  is  sold  in  Great  Britain,  there  is  a  growing  market 
for  them  in  the  United  States.  There  is  no  sound  reason 
wliv  there  should  not  be  a  much  wider  market  for  Cana- 
(lian  securities  in  the  United  States  than  there  is;  for 
there  are  few  better,  and  both  countries  have  much  in 
common  and  clear  ideas  of  each  other's  opportunities 
and  methods.  Already  there  is  a  considerable  amount  of 
United  States  capital  invested  in  Canadian  enterprises, 
more  than  is  generally  appreciated  on  either  side  of  the 
border.  But  so  far,  such  investments  have  been  largely 
confined  to  a  few  wealthy  Americans  or  to  the  big  in- 
dustrials, so  that  the  average  United  States  investor  has 
had  little  interest  in  the  wonderful  development  of  Can- 


li' 


284 


It' 


I 
I 


COaPOKATION  FINANCE 


ada  particularly  in  comparison  with  tlie  vast  influx  of 
British  capital  during  the  last  few  years. 

of  rTS-"'  ^""^^  *"''  -"'""'  '•'»P°n^iWe  for  the  sale 
of  Canadian  securities,  are  becoming  far  more  c'osslv 
associated  with  United  States  financifl  hou"s     T^t 

U^itld  SUtr"'"''  ^"'^  "'  ^""'""''^  -""«-  »  ^ 

iJ^'^t  ''V» /"'■•'y  K^"'  *'I«»i«on  in  Canada  to 
The  r»l  °l  ^^  speculative  and  unworthy  offermg,. 
Ihe  Canadian  investor,  who  is  slowly  becoming  more 
of  a  power  m  his  own  country,  is  beginning  to  esd^w 
worthless  mining,  oil,  land  and  other  stocks  with  wS 
he  IS  baited.  This  situation  was  created  probablyi; 
cause  of  bitter  lessons  learned  in  the  past,  and  te^^ 
»  many  excellent  securities  are  offered'in  tte  4w 

n^  J^l '"  "*"  ~"'"™''  *••'  »™'<»'  in  Canada 
needs  a  higher  rate  of  interest  than  three  per  cent  to 
meet  the  increased  cost  of  living,  which  ap^ars  in  ex- 
pected and  unexpected  places.  Small  bond  denomina- 
tions are  popular,  and  successful  efforts  have  been  made 
by  financial  houses  to  appeal  to  investors  with  limited 
savings.  """cu 

Unlit  ^T^fi  '^'^?*  '■«''«^  community  and  fox  farm 
finance.-An  interesting  development  in  Canadian  cor- 
poration  financing  appeared  in  Canada  in  1912  and  1918 
--the  issue  of  securities  by  fox  farming  companies, 
chiefly  on  Prince  Edward  Island.  The  review  of  busi- 
ness conditions  during  1912,  issued  by  the  Canadian 
Bank  of  Commerce,  referring  to  this  industry,  said: 

Prince  Edward  Island  has  savings  deposits  of  about  $10,- 
000,000,  and  is,  per  capita,  probably  the  richest  rural  com- 
munity in  the  Dominion.  To  its  prosperous  industries  of  agri- 
culture and  fishing  has  been  added  in  late  years  black  fox 


SELLING  CANADIAN  SECURITIES 


285 


ranching,  which  has  reached  important  proportions  and  may 
be  said  to  have  outgrown  the  experimental  stage.  The  present 
stock  of  breeding  animals,  numbering  about  400,  four-fifths  of 
the  total  number  in  captivity  in  the  world,  is  said  to  be  valued 
at  $2,800,000,  and  the  estimated  value  of  the  young  foxes  this 
year  is  $1,800,000.  A  business  which  promises  such  attractive 
profits  may  have  for  a  while  a  disturbing  effect  upon  the  regular 
occupations  of  the  province,  but  the  possibilities  of  breeding  in 
captivity  the  more  valuable  native  fur-bearing  animals  are 
such  as  should  enlist  wide  interest  and  a  careful  study  of  the 
subject. 

Here  is  reproduced  the  prospectus  of  the  Tuplin  Sil- 
ver Black  Fox  Corporation,  Limited,  which  offered 
$200,000  six  per  cent  bonds. 

The  Tuplin  Silver  Black  Fox   G)rporation,   Limited 

WE  OFFER 

^200,000.00  SIX  PER  C£NT  BONDS 

(In  denominations  of  $100.00  and  $500.00) 
at  par,  with  40  Per  Cent  Bonus  of  Common  Stock  of 

The  Tuplin  Silver  Black  Fox  G>rporation,  Limited. 

(Incorporated  under  the  Nova  Scotia  Joint  Stock  Companies'  Act) 


CAPITAUZATION 

6%  Bonds,  redeemable  at  105% $300,000.00 

Common  Stock,  par  value  of  shares  $10.00  each. .  800,000.00 

PAYMENTS    MAY   BE    MADE   IN    FULL,    OR 


25%  on  Application, 
25%  on  April  1st, 


25%  on  May  16th, 
25%  on  July  Ist. 


Interest  payable  semi-annually,  October  1st  and  April  Ist. 
Interim  receipts  for  partial  payments  will  be  exchanged  for 
Bonds  and  Stock  Certificates  when  final  payment  is  made.  Sub- 
scribers have  the  right  to  pay  in  full  at  any  tim%  Accrued 
interest  will  be  charged  on  all  installments  unpaid  on  April  Ist. 


286  CORPORATION  FINANCE 

OIRECTOSS 

J.  H.  Winfield,  General  Manager,  Maritime  Telegraph  &  Tel^ 

phone  Company,  HaUfax Presided 

Prank  F.  Tuplin,  Foxbreeder,  Summerside,  P.  E.  I., 

Vice-President 
Dr.  C.  F.  Fraser,  Director  Eastern  Trust  Co.  .Halifax,  N.  S. 
Hon.  Senator  William  Dennis,  President  Herald  Publishing 

__  /^° Halifax,  N.  S. 

.W.  H.  Covert,  Director  Yarmouth  Light  and  Power  Co., 

_     ,  Halifax,  N.S. 

Dr.  M.  A.  Currj,  Physician Halifax,  N.  S. 

C.  L.  Grant,  Merchant Charlottetown,  P.  E.  I. 

BANKERS 

The  Canadian  Bank  of  Commerce Halifax  N.  S 

SOLICITORS 

Covert  &  Pearson Hulifax,  N.  S. 

TRUSTEES   AND    TRANSFER    AGENTS 

The  Maritime  Trust  Corporation Halifax,  N.  S. 

C.  L.  Grant,  Managing  Director Charlottetown,  P.  E.  I. 

F.  A.  Bowman,  Secretary Halifax,  N.  S. 

FACTS   ABOUT   THE   INDUSTRY 

The  Tuplin  Silver  Black  Fox  Corporation,  Limited,  incor- 
porated under  the  Nova  Scotia  Joint  Stock  Companies'  Act, 
was  organized  for  the  purpose  of  engaging  in 
Purpose  of  the  raising  and  selling  of  the  Silver  or  Black 

Corporation    Fox,  an  industry  which  has  passed  the  experi- 
mental stage  and  presents  the  opportunity  for 
profits  on  a  large  scale. 

The  Corporation's  assets  consist  of  eleven  pairs  of  Silver 
Black  Foxes,  purchased  from  the  famous  ranch  of  Frank  P. 


SELLING  CANADIAN  SECURITIES 


287 


TupHn,  at  New  Annan,  on  the  outskirts  of  Summerside.    This 
stock  consists  of  nine  pairs  of  proved  breeders,  which  pro- 
duced and  raised  thirty-two  pups  in  the  jear 
The  1912,  together  with  one  pair,  one  and  one- 

Assets  half  years,  old,  and  one  pair  raised  in  1912. 

These  foxes  are  the  cream  of  Mr.  Tuplin's 
stock.  Mr.  Tuplin  is  known  as  the  largest  and  most  successful 
breeder  of  Silver  Black  Foxes  in  the  world.  By  process  of 
selection,  from  year  to  year,  he  retained  for  his  own  ranch  the 
pick  of  all  the  foxes  raised,  and  it  is  this  particular  stock  which 
has  been  purchased  by  the  Corporation. 

The  capitalization  of  the  Corporation  consists  of  $300,000.00 
six  per  cent  ten-year  bonds,  redeemable  at  105%,  on  any  in- 
terest date,  and  $300,000.00  of  common  stock 
The  in  shares  of  a  par  value  of  $10.00  each.    It  is 

Capital  estimated  that  the  bonds  will  be  all  redeemed 

within  three  years,  thus  returning  to  the  in- 
vestor his  outlay,  when  the  common  stock  will  have  the  benefit 
of  all  the  net  earnings. 

The  sale  of  these  eleven  pairs  of  foxes  to  the  Corporation  car- 
ries with  it  a  guarantee  of  at  least  twenty-eight  young  foxes, 
to  be  raised  during  the  present  year,  with  a 
Estimated  forfeit  of  $5,000.00  for  each  young  fox  short 

Earnings  of  that  number.    Thus  the  Corporation  has  a 

guaranteed  return  of  twenty-eight  young  as  a 
profit  for  the  first  year.  But  a  conservative  estimate  of  the 
progeny  for  1913  is  thirty-five  foxes. 

Tho  Corporation  has  given  an  option  for  the  sale  of  the 
twenty-°ight  young  at  $4,500.00  each,  so  that  a  market  for  the 
increase  has  been  secured  which  will  make  guaranteed  profits 
for  the  first  year  $126,000.00.  If  the  increase  amounts  to 
thirty-five,  of  which  there  is  little  doubt,  as  nine  pairs  produced 
thirty-two  last  year,  leaving  only  three  to  be  produced  by  the 
other  two  pairs,  the  profits  would  be  $157,500.  The  net  earn- 
ings are  estimated  as  below : — 


f 

Iff 


288  CORPORATION  FINANCE 

35  young  foxes  in  September,  1913,  to  be  sold  at 

$4,500.00  each $157,500.00 

Less  Bond  Interest  at  6% 18,000  00 

r»-  -J     J     r  ,«.,  $139,500.00 

umdend  of  10%  on  common  stock . .      30  COO.OO 

Available  for  sinking  fund  to  redeem  bonds $109,500.00 

Wliile  options  on  the  get  of  1913  are  to-day  selling  for 
$4,500.00,  it  is  confidently  expected  that,  as  in  previous  years, 
prices  will  stiffen  to  higher  figures  before  delivery  date  is 
reached. 

The  mortgage  securing  the  bonds  provides  that  no  dividend 

at  the  rate  of  more  than  107o  per  annum  shaii 

Bond  be  paid  on  the  common  stock  until  all  the 

Redemption     bonds  shall  have  been  redeemed,  and  that  no 

dividend  whatever  on  the  common  stock  shall 

be  paid  in  any  one  year  unless  at  least  $100,000.00  shall  have 

been  paid  off  in  that  year. 

The  market  for  the  Corporation's  output  is  broad  and  ex- 
panding.    Russia  is  a  buyer  and  a  demand  for  breeding  ani- 
mals   comes    from    many    points    outside   of 
^^^  Prince  Edward  Island.    As  to  pelts  the  Silver 

Market  or   Black   Fox   is   the   rarest    fur-producing 

animal  in  the  world  and  its  pelt,  apart  from 
the  value  of  the  animal  as  a  breeder,  brings  the  highest  price  of 
any  fur.  Silver  or  Black  Fox  pelts,  of  good  quality,  readily 
bring  from  $1,000.00  to  .$3,000.00  each.  Undoubtedly  the  ulti- 
mate value  of  the  Silver  Black  Fox  industry  must  be  the  market 
value  of  pelts,  but  there  can  be  no  doubt  that  for  many  years 
the  demand  for  live  stock  from  various  parts  of  the  world,  by 
persons  engaging  in  this  business,  will  be  such  that  the  prices 
for  live  animals  will  much  exceed  the  pelt  value.  It  is  believed 
that  the  present  or  higher  prices  will  obtain  for  seven  or  eigl.t 
years  at  least.  The  sale  of  six  pairs  of  this  year's  pups  to  a 
Russian  company  at  $100,000.00,  or  $16,000  a  pair,  is  a  proper 


SELLING  CANADIAN  SECURITIES 


289 


basis  of  calculation  of  live  stock  value  of  the  season's  litter. 
The  price  on  which  this  Corporation  bases  its  estimates  is  only 
^9,000  per  pair. 

The  contract  with  Frank  F.  Tuplin,  from  whom  the  foxes 
were  purchased,  provides  that  he  shall  care  for  them,  raise  the 

young,  and  attend  to  the  animals  on  his  own 
Maiiaf/ement         ranch  at  New  Annan,  near  Summerside,  until 

September,  1913,  and  the  Corporation  has  his 
guarantee  to  pay  $5,000.00  for  every  fox  less  than  twenty-eight 
that  may  be  produced.  After  that  date  the  Corporation  may 
build  a  ranch,  or  make  a  new  contract  with  Mr.  Tuplin,  who  has 
taken  a  substantial  interest  in  this  Corporation.  The  Tuplin 
ranch,  where  the  Corporation'^,  foxes  are  being  cared  for,  and 
wliere  the  young  will  be  raised,  is  the  best  equipped  in  Prince 
Edward  Island.  It  is  located  on  the  outskirts  of  Summerside, 
admirably  situated  in  the  bush,  with  plenty  of  trees  for  shade 
for  the  animals,  and  is  equipped  with  a  first-class  water  sys- 
tiin,  with  hydrants  for  fire  protection,  washing  pens,  and  gen- 
eral sanitary  requirements. 

The  Directors  decided  that  it  was  in  the  best  interests  of 
tlie  Corporation  to  sell  options  on  the  guarantee  of  twenty- 
eight  at  the  prevailing  figure  today,  reserving 
Breeding  Stock     any  extra  pups  for  sale  on  or  about  delivery 
for  next  year      date  at  the  then  prevailing  figures.     It  may, 
however,  be  decided  to  be  in  the  interests  of 
the  shareholders  to  retain  some  of  the  additional  increase  in 
order  to  produce  higher  returns  next  year. 

The  Corporation's  Solicitors  report  that  the  corporation  has 
luen  duly  and  properly  incorporated  and  organized,  the  bonds 
secured  by  a  mortgage  or  deed  of  trust  to 
LctftiUtif  of  the  Maritime  Trust  Corporation  as  Trustee, 

Organisation     and  the  shares  issued  as  fully  paid  and  non- 
assessable shares,  under  a  certain  contract 

iiniile  with  Chester  McLurc,  dated  the th  day  of — , 


C— VI— 19 


290 


CORPORATION  FINANCE 


A  number  of  Canadians  are  said  to  have  written  to 
the  Department  of  Commerce  at  Washington  seeking 
to  buy  some  of  the  blue  and  silver  foxes  from  the  gov- 
ernment's preserves  in  Alaska,  but  no  citizen  of  the 
United  States  had  made  similar  request  up  to  Julv, 
1913,  although  the  Department  is  understood  to  be  anx- 
ious to  get  citizens  of  the  United  States  to  go  in  for  fox 
breeding. 

It  is  not  necessary  to  discuss  the  matter  here,  further 
than  to  say  that  there  are  undoubtedly  large  profits  in 
the  industry  which  will  probably  result  in  the  formation 
of  numerous  companies.  The  consequent  issue  of  stocks 
and  bonds,  in  turn,  will  create  a  situation  of  interest,  not 
without  danger,  to  he  investor. 


CHAPTER  XVIII 

SELLING  SECURITIES— THE  WALL  STREET  MARKET 

147.  The  principal  stock  exchanges  of  the  United 
States. — The  stock  exchange  oft'ers  the  best  market 
for  a  great  many  corporate  securities.  Some  readers 
are  perhaps  already  familiar  with  the  organization  of 
that  market  and  its  manner  of  conducting  business  and 
will  find  much  of  the  information  given  in  this  chapter 
already  familiar.  In  spite  of  the  importance  of  the 
Wall  Street  stock  exchange,  however,  and  in  spite  of 
the  glib  manner  in  which  almost  every  one  talks  about 
it  and  against  it,  surprisingly  few  people  have  a  correct 
understanding  of  its  operations. 

What  is  said  about  the  Xew  York  Stock  Exchange 
and  Wall  Street  in  this  chapter  applies  in  general,  with 
slight  modifications,  to  a  considerable  number  of  smaller 
stock  exchanges  in  the  larger  cities  of  the  United 
States.     Chief  among  these  exchanges  are: 

(1)  The  Boston  Stock  Exchange,  on  which  local 
securities  are  bought  and  sold  and  which  is  the  chief 
market  for  the  stocks  of  copper-mining  companies. 

(2)  The  Philadelphia  Stock  Exchange,  on  which 
local  securities  and  the  securities  of  the  Lehigh  Valley, 
the  Pennsylvania  and  the  Reading  Railroads  are  bought 
and  sold. 

(3)  The  Pittsburg  Stock  Exchange,  the  principal 
liiisiness  of  which  is  the  handling  of  securities  of  the 
local  steel  companies,  and  of  the  United  States  Steel 

Corporation. 

201 


292 


CORPORATION  FINANCE 


t« 


1^ 


if]}' 


(4)  There  are  stock  exchanges  also  in  Baltimore,  St, 
Louis,  Chicago  and  San  Francisco,  all  of  which  are 
comparatively  small  and  the  operations  of  which  are 
confined  to  local  securities. 

(5)  In  this  group  should  be  included  the  Consolidated 
Stock  Exchange  of  New  York,  or  the  "Little  Ex- 
change,"  as  it  is  frequently  termed,  whose  members  buy 
and  sell  the  same  stocks  that  are  traded  in  on  the  New 
York  Stock  Exchange,  or  "Big  Exchange."  The 
transactions  on  the  Consolidated  are  on  a  much  smaller 
scale  than  on  the  "Big  Exchange";  stocks  are  custom- 
arily  bought  and  sold  in  ten  share  lots  or  multiples  of 
ten,  instead  of  in  one  hundred  share  lots  or  multiples  of 
one  hundred,  as  on  the  New  York  Stock  Exchange. 

The  reader  will  see  from  this  brief  summary  that 
large  aealings  in  securities  of  corporations  of  national 
impor  Lance  are  confined  almost  wholly  to  the  floor  of 
the  New  York  Stock  Exchange.  With  some  excep- 
tions the  stock  of  any  corporation  will  be  bought  and 
sold  on  one  exchange  and  one  only;  the  chief  exceptions, 
to  most  of  which  allusion  has  already  been  made,  are: 
Amalgamated  Copper  Company  stock,  which  is  handled 
both  in  New  York  and  in  Boston;  Pennsylvania  Rail- 
road Company,  Lehigh  Valley  Railroad  Company,  and 
Reading  Railroad  Company,  both  in  New  York  and  in 
Philadelphia;  United  States  Steel  securities,  in  New 
York,  Boston,  Chicago  and  Pittsburg. 

148.  Listing  securities. ~Jn  the  first  paragraph  it 
was  stated  that  the  stock  exchanges  offer  an  excellent 
market  for  the  sale  of  securities  of  certain  corporations 
only.  This  limitation  must  be  stated,  because  each  of  the 
exchanges  confines  Its  members,  so  far  as  trades  on  the 
floor  are  concerned,  to  a  comparatively  small  number  of 
approved  securities.     On  the  New  York  Stock  Ex- 


THE  WALL  STREET  MARKET 


293 


t'liange  all  new  securities  offered  for  approval  are  in- 
vestigated before  being  "listed."  The  Exchange  has 
strict  rules  governing  the  admission  of  securities  to  the 
"listed"  class.  There  is  a  committee  of  five  to  whom 
are  referred  all  applications  for  including  securities 
among  those  listed.  Accompanying  the  application, 
there  must  be  filed  a  complete  description  of  the  prop- 
erty of  the  corporation,  a  full  and  true  balance  sheet, 
an  income  account,  and  information  on  certain  other 
points.  In  the  case  of  bonds  a  full  statement  of  the 
terms  under  which  the  bonds  are  issued,  a  certified  copy 
of  the  mortgage,  and  proof  that  the  mortgage  has  been 
properly  recorded,  must  be  submitted.  The  exchange 
strongly  recommends — a  recommendation  that  has  all 
the  force  of  an  order — that  corporations  whose  securi- 
ties are  listed  shall  furnish  to  their  stockholders  com- 
plete annual  reports  at  least  fifteen  days  prior  to  annual 
meetings. 

]\Iany  industrial  corporations  which  are  unwilling  to 
comply  with  the  requirements  as  to  publicity,  were  for- 
merly admitted  to  the  "unlisted"  class.  This  means 
that  their  securities  were  bought  and  sold  on  the  floor  of 
tile  exchange  in  the  same  manner  as  the  listed  securities, 
and  so  far  as  the  general  public  was  concerned  there  was 
no  apparent  difference  between  the  two  classes.  There 
was,  in  fact,  however,  a  very  important  difference,  for 
the  corporations  whose  securities  were  imlisted  were  not 
required  to  give  complete  reports  as  to  their  opera- 
tions to  the  stock  exchange  committee  or  to  their 
stockholders.  Although  the  public  did  not  appreciate 
the  fact  that  such  a  distinction  existed,  men  in  the  finan- 
cial district  were  fully  alive  to  its  importance.  Listed  se- 
curities almost  without  exception   were  much   more 


Iff^ii/ 


294 


CORPOllATION  FINANCK 


ir 


highly  regarded  by  bankers  and  were  more  acceptable 
as  collateral  for  bank  loans. 

For  this  reason,  most  corporations  preferred  to  meet 
all  the  requirements  and  have  their  securities  listed. 
About  85  per  cent  of  the  securities  handled  on  the  New 
York  Exchange  entered  the  listed  department,  and  the 
unlisted  group— partly  on  account  of  the  force  of  the 
growing  demand  for  publicity— rapidly  doclined  in 
numbers  and  in  importance.  Among  the  last  converts 
from  the  unlisted  to  the  listed  class  were  two  industrial 
companies  of  great  size  and  importance,  the  American 
Sugar  Refining  Company  and  the  American  Smelting 
and  Refining  Company.  Tliis  entrance  into  the  listed 
department  was  rightly  interpreted  as  a  final  proof  that 
the  day  of  corporate  secrecy,  so  far  as  stockholders  are 
concerned,  had  gone  by,  and  shortly  thereafter  the  use- 
less "unlisted"  class  was  abandoned. 

149.  The  Curb  Market— There  are  a  considerable 
number  of  large  corporations  that  are  unwilling  or 
unable  to  furnish  even  the  very  moderate  amount  of 
information  that  is  necessary  in  order  to  have  their  se- 
curities entered  on  the  Stock  Exchange  list.  There  are 
other  securities  that  are  very  highly  speculative  in  their 
nature,  or  that  are  issued  by  corporations  which  are  not 
honestly  and  efficiently  managed— "cats  and  dogs" 
such  securities  are  called  in  Wall  Street  slang— which 
are  bou^rht  and  sold  in  considerable  quantities  in  the 
Wall  Street  district.  As  such  securities  would  not  be 
admissible  under  the  rules  of  any  reputable  exchange, 
an  outside  unorganized  market  has  come  into  existence. 
This  is  known  as  the  Curb  [Market,  for  the  reason  that 
the  meetings  of  the  brokers  who  participate  in  it  are  held 
in  the  open  air  in  one  of  the  streets  in  the  Wall  Street 
district  near  the  street  curb.    There  are  no  written  rules 


THE  WALL  STREET  MARKET 


295 


and  no  fixed  organization  for  the  Curb  Market.  Any- 
one may  go  among  the  throng  of  brokers  standing  on 
the  street  and  buy  or  sell  securities  if  he  can  find  anyone 
else  to  trade  with  him.  As  a  matter  of  fact,  however, 
a  stranger  would  not  be  able  to  transact  any  business, 
for  no  one  would  be  sure  that  he  would  live  up  to  what- 
ever obligations  he  might  contract.  In  practice,  in  or- 
der to  do  business  on  the  "Curb,"  a  broker  must  either 
have  high  standing  and  reputation  on  his  own  account 
or  must  be  a  representative  of  an  established  brokerage 
firm.  Among  the  well-known  and  important  nrpora- 
tions  whose  securities  are  bought  and  sold  in  the  Curb 
Market  we  may  mention  the  former  subsidiaries  of  the 
Standard  Oil  and  American  Tobacco  companies  and 
a  number  of  industrials,  the  stocks  of  which  are  also 
traded  in  on  local  exchanges  outside  New  York,  such  as 
the  Baldwin  Locomotive  Company,  the  J.  I.  Case  Com- 
pany, Cluett-Peabody  Company,  Goodrich  Company 
and  Studebaker  Company.  Most  of  the  other  active 
stocks  on  the  Curb  Market  are  of  mining  companies. 
The  Curb  Market  is  also  the  center  of  transactions  in 
"rights"  (which  are  described  in  Chapter  XXIV)  and 
in  contracts  for  purchase  and  delivery  of  stock  and 
bonds  that  are  not  yet  issued.  Such  stocks  and  bonds 
are  traded  in  "w.  i.,"  to  use  the  Wall  Street  abbrevia- 
tion, which  stands  for  "when  issued." 

150.  Stoch  Excliange  methods. — The  scene  on  the 
floor  of  any  of  the  regular  stock  exchanges  and  on  the 
street  where  the  curb  brokers  congregate  always  seems 
to  an  uninitiated  observer  strange  and  confusing.  On 
the  larger  exchanges  he  sees  a  number  of  posts  set  up 
at  regular  intervals,  each  post  bearing  the  initials  of 
several  of  the  corpoi  ations  whose  securities  are  listed  on 
tliat  particular  exchange.    Around  each  post,  if  it  is  a 


i  I 


M 


296 


CORPORATION  FINANCE 


M  1 


r 


rf' 


i 


ry; 


is  i 


busy  day,  are  a  large  number  of  brokers,  eaeh  armed 
with  a  pencil  and  a  memorandum  jjad,  and  many  of 
them  engaged  in  making  frantic  signs  to  other  brokers. 
The  signs,  which  are  unintelligible  to  the  outsider,  in- 
dicate offers  to  buy  at  a  certain  price  or  acceptances. 

A  broker  who  has  the  stock  or  bonds  of  any  corpora- 
tion to  sell  goes  to  the  post  to  which  that  corporation 
is  assigned,  offers  his  stock  and  receives  bids.  Any 
reader  who  has  never  visited  an  exchange  must  not  get 
the  idea  that  this  proceeding  is  as  simple  and  unexciting 
as  it  seems  when  described  in  cold  print.  If  the  market 
is  at  all  active,  the  seller  may  have  to  fight  his  way  to 
the  center  of  a  struggling  group,  yell  out  his  offer  at 
the  top  of  his  voice,  and  accept  one  or  more  of  the  bids 
that  may  be  yelled  back  at  him  in  the  twinkling  of  an 
eye.  The  noise  that  comes  from  the  floor  of  a  crowded 
stock  exchange  during  an  active  business  day  resembles 
nothing  so  much  as  the  roaring  of  wild  beasts. 

It  has  often  been  remarked,  as  an  indication  of  the 
good  faith  and  high  standards  of  honor  that  must  pre- 
vail as  a  rule  among  stock-exchange  brokers,  that  in  the 
midst  of  all  this  confusion  and  outcry  a  hasty  sign  from 
the  purchaser  and  a  nod  from  the  seller  of  a  block  of 
securities  may  close  a  deal  involving  thousands  of 
dollars.  Each  broker  makes  his  own  memorandum  of 
the  transaction  and  at  the  close  of  the  day  the  houses 
which  they  represent  compare  notes  and  through  the 
stock  exchange  clearing  house  settle  their  balances.  It 
is  very  seldom  that  a  serious  error  or  even  a  misunder 
standing  occurs.  Differences  of  opinion  as  to  prices 
and  quantities  of  securities  are,  of  course,  inevitable 
once  in  a  while,  but  are  usually  adjusted  in  the  friend- 
liest manner. 

The  volume  of  business  transacted  in  this  manner  on 


THE  WALL  STREET  MARKET 


297 


the  leading  stock  exchanges  is  enormous.  Million 
share  days  on  the  New  York  Stock  Exchange,  though 
boinewhat  ahove  the  average,  are  not  at  all  uncommon. 
In  other  words,  $100,000,000  worth  of  business  is  trans- 
acted. Of  course  it  goes  without  saying  that  such 
quantities  of  shares  are  not  bought  outright,  taken  out 
of  the  market  and  placed  in  a  vault.  On  the  contrary, 
the  great  mass  of  the  business  of  buying  and  selling  is 
speculative.  What  is  actually  bought  and  sold  is  the 
right  to  receive  or  the  right  to  deliver  certain  quantities 
of  shares  at  the  end  of  the  day  at  the  price  tixed  in  the 
deals  between  brokers.  In  most  cases  no  actual  delivery 
is  made.  Through  the  stock  exchange  clearing  house 
the  transactions  in  the  same  stock  offset  each  other  and 
only  the  balances  are  delivered  by  those  who  sold  to  those 
Avlu)  buy.  jNIany  floor  traders  seldom  see  any  stock 
certificates  because  they  make  it  a  rule  to  sell  during  the 
day  as  much  as  they  buy.  They  make  both  sales  and 
purchases  with  the  view  to  "scalping"  small  profits,  % 
and  1/1  per  cents. 

L)l.  Importance  of  speculative  dealings. — Nothing 
need  be  said  here  as  to  the  ethics  of  speculation,  a  sub- 
ject which  is  adequately  treated  in  another  volume.  It 
may  be  well  to  remark,  however,  that  all  these  specula- 
tive transactions  on  the  stock  exchange,  particularly  the 
small  transactions,  perfoim  at  least  one  very  useful 
service,  namely,  they  tend  to  steady  security  prices. 
O!)viously,  if  a  stock  starts  to  move  up  or  down  and  a 
group  of  floor  traders  are  at  hand  all  trying  to  sell  at 
each  slight  advance  with  a  view  to  getting  their  small 
speculative  profits,  the  price  will  probably  not  soar  very 
rapidly.  Tlie  same  remark  in  substance  will  apply  to 
all  speculative  dealings. 

Enough  has  been  said  about  the  stock  exchanges  and 


'  f 


J 


298 


CORPORATION  FINANCE 


1)1 


'li 


It)  A 


Hi 


I'. 


Stock  and  bond  brokers  to  give  some  idea  perhaps  of 
their  methods  of  operation.    It  is  no  part  of  the  business 
of  stockbrokers  to  l)iiy  and  sell  to  any  large  extent  on 
their  own  account,  although  many  of  them,  to  be  sure, 
do  not  by  any  means  abstain  from  so  doing.     Their 
main  function,  however,  is  to  serve  as  agents  for  other 
persons  who  may  desire  to  buy  or  sell  securities.    Some 
of  these  persons  are  true  investors  who  are  either  parting 
with  some  of  their  stockholdings  for  cash  or  are  buying 
securities  outright  with  a  view  to  holding  them  for  the 
sake  of  dividends  and  of  future  increases  in  their  value. 
Such  persons,  however,  are  in  the  minority;  most  of  the 
buying  and  selling  of  stocks  on  the  stock  exchanges  is 
speculative.     Of  this  speculative  business  a  small  pro- 
portion is  carried  on  by  the  outright  purchase  of  stocks 
or  bonds,  which  the  purchaser  hopes  will  rise  in  value 
within  a  short  time  so  that  he  may  sell  at  a  substantial 
profit;  or  by  tlie  outright  sale  of  securities  which  the 
seller  hopes  to  be  able  to  buy  back  within  a  short  time 
at  a  substantial  reduction.    The  great  mass  of  specula- 
tive business,  however,  and  for  that  matter  of  all  the 
business  transacted  in  Wall  Street,  consists  of  buying 
and  selling  "on  margin." 

152.  Btii/ing  on  margin.— By  marginal  transactions 
are  meant  those  in  which  most  of  the  necessary  funds 
are  borrowed  and  only  a  small  percentage  or  "margin" 
is  required  of  the  person  for  whom  the  securities  are 
bought  or  sold.  The  procedure  in  making  a  marginal 
speculative  purchase  is  somewhat  as  follows:  The 
speculator  desires  to  own,  we  will  say,  one  hundred 
shares  of  a  stock  which  is  selling  at  or  near  a  par  of 
$100;  the  least  margin  lliat  will  be  accepted  by  reputable 
brokers  in  such  a  case  will  be  $10  per  share.  The  specu- 
lator, therefore,  assuming  that  he  does  not  already  have 


THE  WALL  STREET  MARKET 


299 


an  account  with  his  broker,  gives  hiin  a  check  for  $1,000 
and  an  order  to  buy  the  one  hundred  shares.    A  repre- 
sentative of  the  brokerage  firm  buys  the  one  hundred 
shares  on  the  floor  of  the  exchange  in  the  manner  already 
described.    At  the  end  of  the  day  he  must  be  prepared 
to  pay  for  the  shares,  which  means  an  outlay  of  approxi- 
mately $10,000  (100  shares  at  $100  each).     In  order 
to  raise  this  amount  the  broker  arranges  with  his  bank 
to  accept  the  shares,  after  they  are  bought,  as  collateral 
for  a  loan,  which  on  standard  stocks  will  be  about  80 
per  cent  of  the  market  value,  or  on  this  block,  $8,000. 
There  still  remains  a  difference  of  $1,000  which  the 
broker  must  supply  out  of  his  own  funds.    If  the  stock 
sliortly  after  this  transaction  advances,  we  will  say  ten 
points,  the  fortunate  speculator  will  perhaps  give  an 
order  to  sell,  and  the  broker  will  secure  approximately 
$11,000  for  the  block.    With  this  he  repays  the  bank 
loan  of  $8,000,  reimburses  himself  for  his  loan  of  $1,000 
and  after  deducting  interest  on  the  $9,000  supplied  by 
the  bank  and  by  himself  and  deducting  his  brokerage 
charges,  he  turns  the  rest  over  to  the  speculator.    On 
the  other  hand,  if  the  stock  goes  down  seven  or  eight 
points  the  speculator  is  called  upon  to  put  up  additional 
marf?in  or,  failing  that,  the  broker  sells  the  stock,  repays 
the  bank  loan,  reimburses  himself,  deducts  interest  and 
brokerage  charges  as  before,  and  returns  to  the  specu- 
lator anything  that  may  happen  to  be  left  of  his  $1,000. 
1.53.  Selling  short— If  the  speculator  chooses  to  sell 
on  margin,  or  "sell  short"  in  the  Wall  Street  phrase,  he 
deposits  his  $1,000  as  before  and  orders  the  broker  to 
sell.    The  broker's  representative  executes  the  sale  on 
the  floor  of  the   exchange   and   of  course   is   called 
upon  to  make  delivery  at  the  end  of  the  day.     As 
neither  the  speculator  nor  the  broker  owns  the  stock  that 


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has  been  sold,  it  is  necessary  for  the  broker  to  borrow 
the  stock  from  some  owner.    This  he  does  in  the  "loan 
corner,"  as  it  is  called,  of  the  stock  exchange,  where 
stocks  are  loaned  to  "shorts"  on  payment  of  the  market 
price.    In  form  this  loan  is  a  sale  of  stock ;  it  is  provided, 
however,  that  on  return  of  the  stock  the  amount  paid 
for  the  stock  will  be  given  back.    This  borrowed  stock 
the  broker  uses  to  make  delivery  of  the  block  that  he  has 
sold     If  within  a  short  time  the  stock  goes  down,  the 
fortunate  speculator  orders  his  broker  to  buy  a  block 
at  the  lower  price;  the  broker  uses  the  block  that  he  buys 
to  repay  the  lender  of  the  stock  with  which  delivery  was 
originally  made.     He  turns  over  to  the  speculator  his 
$1,000  margin  plus  the  difference  between  the  price  at 
which  the  block  of  stock  wa   sold  and  the  price  at  which 
it  was  bought  and  minus  brokerage  charges.    The  bro- 
kerage house,  when  it  borrowed  stock  with  which  to 
make  delivery,  paid  to  the  lender  the  market  value  of  the 
stock  and  is  allowed  interest  on  this  sum ;  the  speculator, 
therefore,  in  his  "short"  operations  is  relieved  of  interest 
charges.    On  the  other  hand,  if  the  stock  goes  up  several 
points  in  this  case,  the  broker  will  call  for  more  margin; 
failing  that,  he  will  buy  a  block  of  stock  with  which 
to  repay  the  stock  he  has  borrowed,  will  deduct  from 
the  speculator's  margin  the  difference  between  the  price 
at  which  the  stock  was  sold  and  the  price  at  which  it 
was  bought,  together  with  brokerage  charges,  and  will 
then  return  to  the  speculator  anything  that  may  be 
left  of  his  $1,000. 

154.  Stock  exchange  houses  vs.  bucket  shops. — The 
following  quotation  from  a  circular  letter  issued  by  a 
large  brokerage  house  gives  an  accurate  statement  of 
the  terms  upon  which  reputable  brokers  handle  marginal 
transactions: 


THE  WALL  STREET  MARKET 


801 


We  execute  commission  orders  for  the  outright  purchase,  in 
any  amount,  of  listed  stocks.  Our  charge  is  that  fixed  for  all 
members  of  the  New  York  Stock  Exchange,  Vs  of  1  per  cent 
of  the  par  value,  or  12^/2  cents  a  share,  except  that  we  make  a 
minimum  charge  of  $1  for  any  one  transaction. 

Our  requirement  for  doing  business  upon  margin  is  10  per 
cent  upon  the  par  value  of  the  active  Stock  Exchange  issues 
quoted  at  50  or  below;  15  per  cent  for  those  quoted  between 
50  and  100;  and  20  per  cent  for  those  quoted  above  100.  We 
reserve  the  right,  when  opening  f>  margin  account,  to  refuse  to 
purchase  those  securities  which  either  have  not  a  ready  market 
or  are  not  available  for  collateral  purposes.  Those  who  desire 
to  sell  active  stocks  short,  may  do  so  upon  a  maintained  margin 
of  15  per  cent,  in  the  case  of  stocks  selling  at  par  or  below,  and 
upon  a  margin  of  20  per  cent  in  the  case  of  those  selling  above 
par,  we,  of  course,  to  reserve  the  right  to  discriminate  against 
any  particular  securities. 

Wc  do  not  buy  or  sell  less  than  100  shares  of  stock  or 
$10,000  of  bonds,  upon  margin,  so  that  $1,000  is  the  least 
amount  with  which  such  an  account  can  be  opened.  Our  in- 
terest charges  depend  upon  the  cost  of  our  own  funds  and  are 
figured  at  the  end  of  each  month,  so  we  cannot  say  in  advance 
just  what  rate  will  be  charged,  but  we  will  be  glad  to  take  this 
question  up  in  detail  at  any  time. 

In  opening  margin  accounts  we  require  either  a  bank  refer- 
ence or  an  introduction  from  some  of  our  friends. 

We  never  open  margin  accounts  for  women  or  in  the  name 
of  a  woman  nor  do  we  open  margin  accounts  for  bank  officials 
or  bank  employees. 

Just  a  word  should  be  said  here  about  bucket  shops 
and  swindling  brokerage  concerns  of  all  kinds.  The 
characteristic  of  all  such  concerns  is  that  whatever 
money  is  turned  over  to  thdm  for  buying  and  selling 
stocks  nev-r  gets  out  of  their  own  pockets.  Whatever 
may  be  saiu  as  to  the  ethics  of  true  stock  exchange 


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III! 


speculation,  and  as  to  its  moral  and  economic  effects, 
it  is  certainly  true  that  Wall  Street  ought  not  to  be 
blamed  for  the  existence  of  the  methods  of  the  bucket 
shops.  Wall  Street  brokers  are,  as  a  rule,  entirely 
honorable  in  their  dealings  with  customers.  They  make 
it  their  business  to  execute  whatever  orders  are  given 
to  them  by  their  customers  under  conditions  which  are 
fully  and  clearly  set  forth.  If  :  Ije  customer  misunder- 
stands those  conditions  or  misji  Iges  the  market,  it  is 
his  own  .ault,  not  the  broker's.  A  legitimate  broker 
will  make  every  effort  to  guide  his  customer  aright  and 
protect  him  from  loss,  for  the  broker's  reputation  and 
success  depend  directly  on  the  success  of  his  customers. 
The  bucket  shop,  on  the  other  hand,  obviously  prospers 
from  the  losses  of  its  customers. 

155.  The  classes  of  Wall  Street  speculators.— The 
Wall  Street  speculative  contingent  may  roughly  be  di- 
vided into  three  classes:  first,  Wall  Street  men,  bank- 
ers, brokers  or  corporation  officials,  who  buy  and  sell 
securities  on  a  large  scale  and  who  make  it  their  business 
to  keep  in  constant  touch  with  all  that  goes  on  in  the 
stock  market ;  second,  substantial  men  of  property  and 
business  standing  whose  first  interests  are  not  in  the 
Wall  Street  game,  but  who  take  a  "flier"  once  in  a  while 
in  some  security  or  group  of  securities  of  which  they 
have  special  knowledge;  third,  the  liangcrs-on,  the  true 
lambs,  a  class  made  tip  largely  of  professional  men, 
brokcti-down  business  men  and  women,  who  are  suffer- 
ing under  the  delusion  that  they  can  make  money  in 
WhII  Street  without  having  a  special  knowledge  either 
of  Wall  StrccI  mclhods  nr  of  the  conditions  in  some  par- 
ticular line  of  industry.  This  third  class  is  by  no  means 
.so  large  as  the  niornlists,  the  muck-rakers  and  the  comic 
papers  repre.«jent;  yet  it  is  true  that  its  representative!! 


THE  WALL  STREET  MARKET 


;303 


arc  only  too  painfully  in  evidence.  1 .  is  true  also  that 
the  Fucnibers  of  this  class  inevitably  lose  in  the  long  run, 
and  that  too  often  they  are  infected  with  a  poison  that 
ruins  them  both  financially  and  morally.  It  is  more 
than  doubtful,  however,  if  Wall  Street  ought  to  be  held 
responsible  for  the  losses  of  such  people.  For  the  most 
part  tliey  are  weak  and  foolish  and  it  may  safely  be  said 
that  if  they  had  not  fallen  victims  to  the  Wall  Street 
cra/e  tliev  would  have  found  some  other  means  of  losinir 
their  monev. 

* 

1.3G.  A  summary  vieiic  of  the  stock  market. — What 
j)retedcs  is  intended  to  present  to  the  reader  a  bird's- 
eye  view  of  the  Wall  Street  market,  or  the  stock  ex- 
change market,  for  securities.  To  recapitulate:  only  a 
comparatively  few  large  corporations  have  their  secur- 
ities listed  on  any  of  the  stock  exchanges;  those  corpora- 
tions whose  securities  are  listed  have  a  M'ell-advertised, 
continuous  and  easily  accessible  market  for  their  secur- 
ities; this  market  is  utiliy.ed  both  by  investors  and  by 
sjjeculators,  but,  so  far  as  stocks  are  concerned,  the  spec- 
ulative element  is  of  chief  importance;  most  of  the 
speculation  is  carried  on  by  means  of  marginal  pur- 
chases and  sales;  the  speculators  may  be  classified  under 
the  three  heads,  Wall  Street  operators,  business  men  and 
"lambs."  With  these  leading  facts  before  us,  we  are 
noAv  ready  to  discuss  briefly  the  process  of  selling  a  new 
security  through  the  stock  exchange  markets. 

^yf.  Stimulating  speculative  interest. — If  u  ,  new 
security  is  a  small  issue  put  out  by  one  of  the  less  im- 
portant companies,  the  process  of  selling  it  through  a 
•^tock  exchange  will  not  be  much  difl'erent  from  that 
^vliich  has  been  described  in  previous  chapters.  The 
new  security  will  be  advertised,  inquiries  will  he  invited, 
an  alluring  prospectus  will  l)e  issued,  the  new  security 


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CORPORATION  FINANCE 


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will  be  listed  and  the  corporation  managers  will  then  sit 
back  and  wait  for  orders  to  reach  them. 

Let  us  suppose,  however,  that  a  new  stock  of  a  large 
issue  is  to  be  put  out  by  )ne  of  the  well-known  com- 
panies. In  that  case,  the  corporation  managers,  or  the 
syndicate  which  is  underwriting  and  handling  the  sale 
of  that  stock,  will  not  only  take  all  the  means  mentioned 
in  the  preceding  paragraph  to  insure  the  success  of  the 
sale,  but  will  go  further.  Tiiey  will  take  measures  to 
create  a  si^eculative  interest  in  the  stock  and  to  "make  a 
market"  at  a  good  price. 

In  addition  to  their  advertisements  and  prospectuses, 
they  will  probably  set  to  work  other  forces  still  better 
fitted  to  secure  buj'ing  orders  from  marginal  specula- 
tors. Xow  the  average  speculator  is  not  much  attracted 
by  brass  band  announcements  or  even  by  newspaper 
stones,  no  matter  how  well  written  and  convincing  they 
may  seem.  But  he  rises  to  a  tip  like  a  hungry  fish  to 
the  bait.  He  reasons  that  what  is  known  to  evervhodv 
will  bring  little  profit  to  himself,  but  that  information 
which  comes  to  h'm  confidentially  by  word  of  mouth 
gives  him  an  exceptional  opportunity.  Therefore,  AVall 
Street,  from  morning  to  night  in  an  active  market,  hums 
with  tips,  rumors  and  gossip.  The  tips  that  are  thus 
circulated  are  not  all  valueless  by  any  means,  although  it 
must  be  admitted  that  a  speculator  who  follows  them  too 
closely  will  ])robably  be  a  heavy  loser  in  the  end.  The 
first  move,  then,  of  the  managers  of  a  large  rew  stock 
issue  will  proba])ly  be  to  see  to  it  that  rumors  as  to  the 
extent  an;]  high  quality  of  the  issue,  and  above  all,  as  to 
the  "interests"  thnt  will  support  its  market  price,  begin 
to  pjrculnte.  Thus  the  Mppctite  of  speculators  will  he 
stimulate*!  and  large  buying  orders  from  them  will  prob- 


THE  WALL  STREET  MARKET 


305 


ably  await  the  first  appearance  of  the  stock  on  the 

market. 

The  next  step  will  be  to  range  the  brokers  in  favor  of 
the  new  issue,  so  that  whatever  advice  they  give  to  their 
customers  will  tend  to  favor  its  purchase.  The  most  di- 
rect method  of  securing  the  brokers'  favorable  attention 
is  by  seeing  to  it  that  the  new  stock  is  acceptable  as  col- 
lateral for  bank  loans.  Partly  for  this  reason  it  is  very 
important  that  among  the  persons  interested  from  the 
be^iiming  in  the  new  issue  should  be  representatives  of 
large  banking  interests.  If  the  broker  feels  sure  that 
the  stock  will  be  acceptable  as  collateral,  he  knows  that 
AC  will  be  able  to  carry  large  amounts  of  it  for  his  cus- 
tomers on  easy  terms. 

1)8.  Syndicate  operations. — The  next  step  is  to  se- 
cure an  apreenient  among  the  syndicate  members  and 
j)erhaps  w.  large  banking  and  brokerage  interests  out- 
side the  syndicate  that  the  price  of  that  particular  re- 
curity  will  be  held  at  a  given  figure.  Thus  when  the 
liiterl)oroug'  .Metropolitan  Company,  the  great  $240,- 
000,000  merger  of  the  transportation  lines  of  New  York 
City,  was  formed,  the  members  of  the  syndicate  were 
said  to  have  agreed  that  the  price  of  the  common  stock 
should  not  be  allowed  to  fall  below  fifty.  In  order  to 
maintain  the  price  at  this  point  they  were  compelled 
at'tt  r  the  stock  had  been  issued  to  purchase  large  blocks 
and  take  them  off  the  market.  In  this  particular  case 
tlie  syndicate,  for  reasons  which  need  not  be  here  dis- 
cussed, went  to  pieces  after  about  a  year,  and  the  price 
of  the  common  stock  suddenly  broke  ver}'  sharply. 
During  the  year,  however,  the  agreement  was  lived  up 
to.  Where  such  an  agreement  is  made  and  maintained 
the  effect  is  to  steady  the  price  of  the  stock,  or  at  least 

C— VT— 20 


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CORPORATION  FINANCE 


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to  hold  it  above  the  figure  agreed  upon,  and  thereby  to 
attract  both  speculators  and  investors. 

159.  Stock  market  manipulation. — The  fourth  step 
in  making  a  market  for  a  new  issue  is  to  manipulate  the 
I)rice  in  such  a  manner  as  to  gain  the  good  will  of  specu- 
lators and  brokers  and  arouse  expectations  of  large 
profits.  Manipulating  a  stock  is  a  process  that  requires 
great  skill,  judgment  and  cool  nerve.  Several  men 
in  the  Wall  Street  district  have  become  famous  for  their 
abilities  along  this  line;  foremost  among  them  is  the 
well-known  and  successful  operator,  the  late  James  R. 
Keene.  To  Mr.  Keene  was  entrusted  most  of  the  large 
speculative  stock  flotations  of  recent  years.  He  was 
almost  uniformly  successful. 

One  method  by  which  a  manipulator  may  fix  a  quota- 
tion for  his  security  is  by  "wash  sales,"  by  which  is  meant 
selling  with  one  hand  and  buying  with  the  other. 
Brokers  on  the  New  York  Stock  Exchange,  according 
to  the  rules  of  the  exchange,  are  not  allowed  to  be 
parties  knowingly  to  such  a  process.  They  are  not  sup- 
posed to  know,  however,  and  as  a  matter  of  fact,  cannot 
know,  whether  or  not  a  selling  order  given  to  them  is 
matched  by  a  buying  order  simultaneously  given  to  an- 
other broker.  By  means  of  such  matched  orders  a  ma- 
nipulator may  raise  or  depress  the  price  of  a  stock  al- 
most at  will  with  no  further  expense  than  brokerage 
commissions — provided,  of  course,  that  his  plans  are  not 
mterfered  with  by  large  buying  or  selling  orders  from 
other  parties.  It  is  customary  for  a  stock  market  ma- 
nipulator in  this  manner  to  fix  or  attempt  to  fix  the  price 
of  a  security  at  the  beginning  and  then  gradually  raise 
Its  price  and  thus  stimulate  speculative  interest  in  the 
security. 

As  the  security  advances  in  price  and  stockholders 


THE  WALL  STREET  MARKET 


307 


begin  to  send  in  their  orders  to  buy,  the  manipulator,  if 
his  plans  work  out  successfully,  gradually  feeds  out 
small  amounts  of  the  stock  that  he  has  on  hand.  This 
process  must  be  very  gradual  and  carried  on  in  such  a 
manner  that  it  cannot  easily  be  observed ;  otherwise,  the 
stock-market  price  will  be  depressed,  stockholders  will 
take  warning  and  will  begin  to  sell  and  the  market  will 
be  spoiled.  Furthermore,  it  is  not  well  to  allow  the  price 
to  go  up  too  rapidly  or  too  steadily;  otherwise  the  ma- 
nipulation will  be  too  apparent  and  furthermore  no  op- 
portunity will  be  given  to  prospective  buyers  to  pur- 
chase at  slight  recessions  from  previous  prices.  The 
price  of  a  skillfully  manipulated  stock  will  move  upward 
and  downward  by  jerks,  the  tendency  on  the  whole  be- 
ing upward.  If  the  manipulation  is  secret  and  skillful, 
not  even  the  most  expert  observer  can  be  certain  whether 
tlie  price  is  subject  to  manipulation  or  not. 

It  will  be  impossible  here  to  enter  into  a  study  of  all 
the  intricacies  of  manipulation  and  of  the  schemes  which 
have  been  successfully  worked  in  the  past.  The  object 
of  this  chapter  is  attained  if  the  reader  sees  that  the  se- 
curities, stocks  especially,  of  large  corporations  may  be 
sold  through  the  stock  market  at  much  higher  prices 
than  would  be  possible  if  the  same  stocks  were  sold  direct 
to  investors.  A  further  study  of  this  interesting  branch 
of  our  subject  will  be  found  in  the  volume  on  Invest- 
ment AND  Speculation, 


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III 


CHAPTER  XIX 

SELLING  SECURITIES— THE  UNDERWRITING 
SYNDICATE 

160.  Origin  of  underwriting. — One  means  of  float 
ing  an  issue  of  securities,  we  have  seen,  is  to  dispose  of 
them  through  the  agency  of  banking  and  brokerage 
houses.  In  such  cases  the  financial  houses  may  not 
merely  undertake  to  sell  the  securities,  but  may  make 
themselves  responsible  for  the  success  of  the  sale.  One 
method  of  so  doing  is  by  agreeing  to  take  for  them- 
selves, if  no  other  purchasers  are  found  within  a  specified 
period,  all  of  the  unsold  portion  of  the  issue  at  a  certain 
agreed  price.  Thus  the  issuing  corporation  is  relieved 
of  part  of  its  risk  and  the  buyers  of  the  securities  are 
made  to  feel  that  well-informed  financiers  have  faith  in 
their  value.  This  process — modified  more  or  less,  as 
described  later  in  this  chapter — is  known  as  under- 
writing. 

The  origin  of  underwriting  is  to  be  found  in  the 
famous  London  institution  called  Lloyd's.  Lloyd's 
Coffee  House  was  the  place  where  the  export  and  import 
merchants  of  London  assembled  in  the  17th  century 
to  transact  their  business  with  shippers.  As  all  such 
trade  at  that  time  was  peculiarly  subject  to  mishaps  of 
all  kinds,  the  practice  grew  up  of  dividing  the  risk  on 
cargoes  and  shipments  among  a  large  number  of  mer- 
chants; each  party  to  the  agreement  wrote  his  name 
under  the  contract  and  from  this  custom  arose  the  name 
"underwri^^ing."    We  are  to  discuss  in  this  chap^^er  the 

308 


THE  UNDERWRITING  SYNDICATE 


3U9 


same  principle  r.s  it  is  now  applied  to  new  issues  of  se- 
curities. The  essential  part  of  the  arrangement  is  the 
iiisiiiiiig  of  someone  against  loss  or  failcire.  A  secon- 
dary feature  is  the  division  of  the  risk  among  a  con- 
siilerable  number  of  people,  so  that  no  one  of  the  in- 
surers is  liable  to  suffer  great  loss. 

IGl.  Advantages  of  underwriting  to  the  corporation. 
— Tliere  are  several  reasons  why  banking  and  brokerage 
lioiises  may  properly  carry  on  this  business  of  financial 
underwriting  and  why  the  business  is  usually  profitable 
both  to  themselves  and  to  the  corporation  which  issues 
the  underwritten  securities.  In  the  first  place,  the 
hankers  are  presumably  experts  in  the  valuation  of  se- 
curities. Their  judgment  as  to  the  price  which  should 
he  set  on  a  new  security  or  as  to  the  terms  of  exchange, 
if  the  new  security  results  from  a  conversion  of  an  old 
security,  is  a  valuable,  authoritative  judgm'^nt.  In  the 
second  place,  the  bankers  are  also  experts  in  selling  se- 
curities and  each  house  involved  in  the  imderwriting 
usually  has  an  established  clientele  to  whom  it  may 
readily  dispose  of  almost  any  securities  that  it  recom- 
mends. The  corporation,  on  the  other  hand,  has  no 
facilities  whatever  for  selling  stocks  and  bonds;  its  ac- 
tivities are  in  the  field  of  transportation,  or  industry,  or 
trade,  not  in  finance. 

Two  further  reasons  are  even  more  potent  in  inducing 
corporation  managers  to  have  new  security  issues  under- 
written. First,  even  though  the  corporation  can  obtain 
expert  financial  advice  and  is  reasonably  sure  to  make 
a  success  ultimately  of  the  sale  of  any  securities  it  puts 
out,  yet  the  time  that  will  eldpse  before  the  sale  is  com- 
pleted and  the  money  received  is  always  uncertain. 
Xow  the  corporation  ordinarily  would  not  be  trying  to 
sell  new  securities  if  it  did  not  need  money  at  once  or  in 


aio 


V  s\ 


CORPORATION  FINANCE 


f!  !C> 


[1  j 

k 


'i 


i .'  5 


II. 


w 


liii 


the  near  future.  It  is  disastrous  to  the  success  of  many 
industrial  or  commercial  operations  to  hold  them  in 
abeyance  until  the  tedious  process  of  selling  a  large  block 
of  bonds  or  stocks  is  completed;  yet  it  is  dangerous  to 
go  ahead  so  long  as  the  sale  is  incomplete.  This  delay 
can  be  aT  aided  by  having  the  security  underwritten 
tor  the  underwriters  will  pay  the  corporation  within  a 
definite  period.  The  second  reason  that  appeals 
strongly  to  corporation  managers  is  that  the  credit  of 
a  corporation  is  seriously  affected  by  any  apparent  in- 
ability to  market  its  securities.  One  failure— or  even  a 
success  that  is  too  hard-won-would  hamper  the  corpo- 
ration greatly  both  in  getting  loans  and  in  making  future 
sales  of  stock. 

162.  Advantage  to  the  buyers  of  securities.— There 
are  telling  advantages  to  the  buyers  of  securities  also  in 
having  them  underwritten.  As  was  pointed  out  in 
Chapter  XVI,  reputable  banking  houses  never  sell  se- 
curities until  after  they  have  been  satisfied  by  a  search- 
mg  investigation  that  the  securities  are  all  that  they  are 
represented  to  be.  Though  this  does  not  mean  a  guar- 
antee on  the  part  of  the  banking  house,  it  does  mean 
that  the  buyer  has  the  advantage  of  their  expert,  and 
presumably  impartial,  examination  of  every  question, 
legal,  financial,  accounting,  engineering  or  commercial! 
that  pertains  to  the  new  security.  This  investigation  is 
expensive;  no  ordinary  investor  could  afford  it  on  his 
own  account.  He  is,  therefore,  willing  to  pay  a  little 
higher  price  for  a  security  if  this  service  has  been  per- 
formed. 

Another  advantage  to  the  buyer  is  that  he  may  be  sure 
that  the  whole  security  issue  has  been  sold  by  the  cor- 
poration. A  half-soKl  issue  is  a  sign  of  weakness  and  a 
hindrance  to  the  completion  of  the  corporation's  plans 


jp«»' 


THE  UNDERWRITING  SYNDICATE 


311 


M  serious  as  to  'reduce  the  value  usually  of  the  portion 
that  has  heen  sold.  Suppose,  for  instance,  that  an  in- 
dustrial company  desires  to  build  a  new  plant  at  a  cost 
of  SI 0,000,000  and  sells  only  $8,000,000  worth  of  the 
securities  which  are  intended  to  finance  the  project. 
Wiiat  can  the  company  do?  It  can  neither  complete 
the  plant  nor  return  the  $8,000,000.  In  all  probability 
the  money  will  be  used  unprofitably  and  the  stocks  or 
bonds  sold  by  the  company  will  be  poorly  secured.  This 
danger  is  avoided  when  the  whole  block  of  securities  is 
taken  at  one  time  by  underwriters. 

A  third  advantage  to  the  buyer  is  that  any  reputable 
hanking  house  will  w^atch  closely  any  security  that  it  has 
underwritten,  and  will  come  to  the  assistance  of  the 
security-holders  in  case  the  corporation  later  gets  into 
difficulties.  As  will  be  brought  out  in  our  study  of  re- 
orLfanization,  the  committees  formed  to  assist  in  devising 
phms  to  reorganize  insolvent  corporations  almost  always 
contain  representatives  of  banking  houses  who  are  there 
to  look  after  the  interests  of  their  clients. 

For  these  reasons  underwriting  certainly  adds  to  the 
value  of  securities.  The  underwriters  naturally  are  not 
impelled  by  charitable  motives;  they  expect  a  reasonable 
compensation  for  their  risk  and  trouble,  and  frequently 
the  compensation  runs  well  up  into  millions  of  dollars. 
Barring  collusion  and  graft,  which  have  been  only  too 
apparent  in  isolated  cases,  it  may  be  laid  down  as  a 
general  rule,  however,  that  the  underwriters  give  more 
tlian  value  received.  There  is  no  question  in  the  writer's 
mind  but  that  our  corporation  financing  is  cleaner  and 
more  efficient  because  underwriting  is  the  general  prac- 
tice. It  is  hard  to  over-estimate  the  value  of  examina- 
tion and  supervision  by  fair-minded  financial  experts. 

1G3.  When  is  undencriting  advisable? — It  must  not 


812 


H'p'r; 


CORPORATION  FINANCE 


? . ! ; 


be  inferred  that  every  new  stock  or  bond  issue  ongl.t  tn 
be  underwritten.  Small  issues,  say  $500,000  or  less 
can  usually  be  sold  to  a  comparatively  small  number  of 
mvestors  by  direct  solicitation  on  the  part  of  the  corpo- 
ration. Then  again,  well-established,  successful  corpo- 
rations frequently  sell  new  stock  or  bond  issues  to  their 
stockholders  at  bargain  prices.  Ordinarily  there  is  no 
risk  in  such  a  sale  and  consequently  no  necessity  for 
underwriting. 

An  interesting  concrete  case,  in  which  there  is  doubt 
as  to  whether  new  issues  of  bonds  should  be  underwritten 
or  not,  was  brought  to  public  attention  in  Mar^h,  1909. 
At  the  annual  meeting  of  the  stockholders  of  the  Penn- 
sylvania Railroad  Company  Mr.  ]Moorfield  Storey,  a 
Boston  lawyer,  submitted  the  following  resolution: 

Whereas,  the  Pennsylvania  Railroad  Company  is  to-day  the 
first  railroad  corporation  in  the  world,  and  its  securities  are 
entitled  to  rank  witli  the  best  that  can  be  offered,  and,  therefore, 
to  command  the  I^-ghest  price  in  tlic  markets,  both  of  this  and 
foreign  countries ;  and, 

Whereas,  There  is  now  abundant  capital  in  ii.e  hands  of 
capitalists  and  combinations  of  capitalist .  thi^  world  over,  who 
are  seeking  opportunities  for  bnyinp  such  seounties,  and  it  is 
desirable  that  the  directors  of  this  conipaiiy  should  Uh  advan- 
tage of  the  opportunity  which  these  conditions  afford  to  obtain 
the  highest  price  possible  for  such  securities  as  the  company 
now  proposes  to  sell ;  and, 

Whereas,  The  sale  of  railroad  securities  to  the  highest  bidder 
after  open  competition  will  do  much  to  remove  the  public  belief 
that  such  securities  are  issued  for  excessive  amounts,  and  thus 
tend  to  prevent  legislation  adverse  to  these  corporations,  which 
is  now  threatened. 

Resolved,  That  the  stockholders  of  the  Pennsylvania  Rail- 
road Company  desire  to  have  the  proposed  issue  of  securities 
80  oflPered  as  to  be  open  to  competitive  bidding  by  responsible 


THE  UNDEKWRITING  SYNDICATE 


313 


li.Miking  houses,  and  thn,t  the  issue  of  securities  should,  be  adver- 
lisiil  in  advance,  it  being  retjuired  that  such  bids  shall  be  acconi' 
jxiiiiwl  by  certified  check  for  such  amount  as  may  be  necessary 
to  insure  good  faith. 

This  reasoning  sounds  plausible  at  the  first  hearing, 
hilt  is  far  from  eonviiicing.  It  fails  to  take  unto  ac- 
count tlie  risks  involved  in  the  proposed  plan  and  the 
advantage  to  the  railroad  of  having  the  right  kind  of 
hanking  connections  in  periods  of  financial  stress.  In 
the  course  of  an  able  discussion  of  this  proposal  the 
Xeic  York  Evening/  Post  said: 

Tliose  who  hold  different  views  appeal  to  the  Pennsylvania's 
own  experience  in  1903.  Early  in  that  year,  when  the  stock 
«iis  selling  around  157,  the  shareholders  were  offered  $75,000,- 
()()l)  new  stock  at  120.  Before  the  time  for  closing  the  sub- 
MTiption  list  expired,  the  price  of  the  old  stock  had  fallen 
almost  to  120,  and  the  management  was  confronted  with  the 
(lifRruIty  that  beset  the  Steel  Corporation  the  same  year,  when 
lionds  which  had  been  offered  to  the  shareholders  at  par  were 
s«  lling  in  the  open  market  at  65.  Needless  to  say,  the  Steel 
bonds  were  finally  sold  to  a  syndicate  and  not  to  the  share- 
lioldcrs.  When  Pennsylvania  dropped  to  around  120,  in  the 
>pring  of  1903,  a  banking  syndicate  was  hastily  formed  to 
inuKrwrite  the  new  issue  for  which  a  commission  of  2y2  P<?r  cent 
was  allowed.  Before  the  whole  operation  was  concluded  the  old 
'tock  had  touched  110%.  Under  favorable  conditions  a  road 
ill  such  high  credit  as  the  Pennsylvania,  the  St.  Paul,  the  Great 
Northern,  the  Union  Pacific,  the  Illinois  Central,  or  the  North- 
Mistern  could  get  a  better  price  for  an  issue  of  bonds  by 

)pping  among  the  international  banking  houses  than  by  con- 


SllOI 


fining  negotiations  to  one  banking  firm.  But  all  of  the  roads 
!:.tt!!((l  have  at  one  time  or  another  been  forced  to  borrow  when 
tlif  prices  of  investment  securities  were  falling  or  when  money 
iiiarkct  conditions  were  unfavorable. 

A  railroad  which  has  established  permanent  banking  connec- 


1   I 


l\ 
1 


8U 


COUPOUATION  FINANCE 


mi 

lib 


rill; 


\U 


tions  has  a  guarantee  that  money  can  be  raised  in  troublesome 
times,  when  necessary,  as  well  as  when  investors  are  clamoring 
for  securities.  When  acting  in  such  capacity  bankers  arc  sup- 
posed to  advise  a  railroad  what  kind  of  securities  will  find  the 
readiest  market  exactly  when  the  securities  should  be  issued,  a 
very  important  point,  and  what  price  the  public  should  be 
asked  to  pay  for  the  issue.  It  is  also  the  business  of  railway- 
bankers  to  protect  the  market  for  a  new  issue  until  the  securities 
reach  the  hands  of  investors. 

1G4.  JFhu  undcrtcriting  sijndicates  are  formed,— li 
would  naturally  be  expected  that  each  of  the  large 
financial  liouses  engaged  in  the  underwriting  business 
would  handle  on  its  own  responsibility  whatever  busi- 
ness comes  its  way,  and  that  rivalry  would  prevent  their 
co-operating  to  any  considerable  extent.  The  fact  is, 
however,  that  these  houses  have  long  since  learned  that 
it  is  inadvisable  for  any  of  them,  no  matter  how  power- 
ful to  guarantee  the  success  of  a  large  security 
issue.  It  is  true  that  the  banker's  judgment  and  ex- 
perience should  enable  him  to  avoid  heavy  risks;  yet  a 
certain  amount  of  risk  is  inevitable.  A  banker  does  not 
know  what  may  happen  in  the  financial  world,  does  not 
know  when  the  bankruptcy  of  some  big  concern  or  un- 
expected political  events  may  create  a  sudden  panic. 
If  he  is  caught  at  such  a  time  with  his  funds  tied  up  in  a 
large  issue  of  new  and  unsalable  securities,  he  may  be 
forced  into  bankruptcy  and  is  almost  certain  to  suffer 
severe  loss.  It  is  not  considered  conservative  banking, 
therefore,  for  any  one  house  or  even  any  two  or  three 
houses  to  underwrite  a  large  issue.  I>iany  banking 
houses  follow  a  definite  policy  in  this  respect  and  refuse 
absolutely  to  underwrite  more  than  a  certain  sum,  say 
$100,000  or  $.)00,000  or  $1,000,000,  depending  on  the 
size  of  the  house,  even  when  the  risk  seems  particularly 
small. 


THE  UNDKUWUITING  SYNDICATF 


315 


Another  reason  for  co-operation  among  bankers  is 
llial  each  house  desires  to  offer  a  variety  ol'  securities 
to  its  clientele.  If  it  specializes  too  much  or  offers  only  a 
tew  securities,  it  cannot  expect  to  attract  and  hold  reg- 
ular ciistomers. 

A  third  reason  for  co-operation  is  in  order  that  a 
Itioad  geographical  distribution  may  be  obtained  and  the 
ale  of  the  security  issue  be  made  correspondingly  easy. 
A  Pittsburg  steel  company,  we  will  say,  is  putting  out 
a  large  new  bond  issue  and  gets  a  New  York  banking 
house  to  underwrite  the  issue.  New  York  and  Pitts- 
hiirg  investors  may  be  loaded  with  similar  bonds  already; 
under  such  circumstances  the  New  York  banking  house 
will  certainly  invite  houses  in  Boston  and  Chicago  and 
other  centers,  which  are  not  yet  saturated  with  such 
bonds,  to  participate  in  the  underwriting. 

For  these  reasons  the  banks  and  brokerage  houses  that 
handle  this  business  on  a  large  scale  always  band  them- 
selves together  in  the  case  of  an  issue  of  considerable 
size  into  an  underwriting  syndicate.  By  means  of  the 
syndicate  the  risk,  the  trouble  and  the  profits  are  div*  '^d 
among  several  houses.  The  sjTidicate  so  formed  may 
lielong  to  any  one  of  five  types. 

10.5.  Five  Ujpes  of  syndicates. — Originally  the  nor- 
mal arrangement  was  to  have  the  syndicate  as  a  whole 
j>narantee  the  price  of  the  issue,  and  let  the  corporation 
attend  to  the  selling.  Under  this  plan,  to  give  an  ex- 
ample, a  corporation  putting  out  a  $.),000,000  bond  issue 
would  offer  the  bonds  to  the  public  at  a  fixed  price, 
say  95,  and  the  syndicate  would  agree  to  accept  any  of 
the  bonds  not  bought  by  the  public  at  a  lower  price,  say 
00.  This  is  underwriting  in  the  original  sense  of  the 
word,  it  is  a  species  of  insurance.  Under  siich  a  plan 
the  syndicate  would  have  two  sources  of  profit;  first,  a 


«^!' 


316 


CORPORATION  FINANCE 


?  i 


i  < 


'I  i 


11 

:   I 

if 


III 


commission  on  the  portion  sold  to  the  public,  or  a  fixed 
bonus;  and,  second,  the  difference  between  the  whole- 
sale price  to  them  and  the  retail  price  at  >vhich  they 
would  ultimately  dispose  of  the  bonds.  The  ordinary 
commission  would  range  between  2  and  5  per  cent. 
This  type  is  seldom  used  nowadays,  principally  for  the 
reason  already  given  that  the  corporation  is  not  well 
equipped  to  attend  to  the  sale  of  securities. 

A  second  type,  also  rather  unusual,  is  a  syndicate 
formed  to  take  an  "underwriter's  option."  Under  this 
plan  the  syndicate  takes  the  block  of  bonds  or  stock  at 
a  fixed  price,  payable  only  as  resold.  As  fast  as  the 
syndicate  disposes  of  the  bonds  it  turns  over  the  proceeds 
to  the  corporation,  after  deducting  whatever  it  receives 
above  the  fixed  price.  The  corporation  pays  somewhat 
less  for  this  service  than  for  other  kinds  of  underwriting, 
because  the  syndicate  takes  no  risk ;  on  the  other  hand, 
as  the  corporation  cannot  be  certain  when  it  will  get  its 
money,  the  type  is  not  much  favored  by  conservative 
corporation  managers. 

The  third  type  of  syndicate  comes  into  existence  when 
a  large  banking  house  has  bouglit  for  itself  a  big  secur- 
ity issue  and  wishes  to  distribute  the  risk.  In  such  a 
case  the  original  underwriter  frequently  calls  upon  other 
banking  houses  and  upon  individuals  to  take  portions  of 
the  issue  at  prices  low  enough  to  be  attractive.  The 
agreement  with  the  parties  who  are  called  in  may  be  ex- 
ecuted in  anticipation  of  a  contract  that  is  about  to  be 
made  between  the  original  imderwriter  and  the  corpora- 
tion. Full  details  as  to  an  excellent  example  of  tlis 
type  of  underwriting  syndicate  will  be  found  in  the 
agreement  made  in  order  to  guarantee  the  conversion  of 
the  United  States  Steel  Corporation  preferred  stock, 
which  is  given  in  full  on  pages  270-277. 


THE  UNDERWRITING  SYNDICATE 


317 


1G().  A  fourth  type — [woling  the  sale  of  the  security. 
—The  fourth  type  of  syndicate  acts  as  a  unit  in  making 
a  contract  for  the  purchase  of  an  issue  and  pools  the 
sale  of  tlie  stock  or  bonds.  The  chief  difference  between 
the  third  and  fourth  types  lies  simply  in  the  fact  that 
the  syndicate  members  deal  directly  with  the  corpora- 
tion, not  with  a  banking  house.  They  thus  secure  for 
themselves  all  the  profits  of  the  underwriters.  Such  a 
syndicate  is  always  managed  by  some  one  house  or  in- 
dividual having  complete  authority.  Its  organization 
and  management  are  further  discussed  below.  On  the 
whole,  this  is  probably  the  best  lown  and  most  common 
form  of  large  syndicates. 

To  illustrate  the  workings  of  this  type  we  will  sup- 
pose that  a  syndicate  has  been  formed,  under  the  leader- 
ship of  Speyer  &  Company,  to  underwrite  a  $25,000,000 
bond  issue  at  90;  to  the  public  the  price  of  the  issue,  we 
will  say,  is  95.  One  concern  may  agree  to  take  $1,000,- 
)0,  or  one-twenty-fifth  of  whatever  amount  the  public 
fails  to  buy;  another  concern  may  take  $2,500,000,  or 
one-tenth  of  whatever  is  left  unsold,  and  so  on.  All  the 
bonds  are  left,  in  this  form  of  sjTidicate,  with  Speyer 
k  Company,  who  offer  the  bonds  to  the  public  and  sell 
all  that  they  can.  If  the  whole  issue  is  taken  by  the 
public,  each  party  to  the  syndicate  receives  his  profits, 
after  deducting  expenses,  without  further  trouble.  If 
the  public  does  not  take  the  whole  issue,  each  member 
must  take  his  agreed  proportion  at  the  syndicate  price, 
00.  In  good  times  the  risk  in  such  a  transaction  is 
slight;  if  the  public  is  indisposed  to  buy  bonds,  however, 
or  if  any  serious  mistake  in  their  valuation  has  been 
iniule,  the  sjTidicate  members  may  lose  heavily. 

1(57.  A  fifth  type— distributing  the  security.— T!\\e 
nooUng  arrangement  a\w\c  described,  although  it  se- 


;3i8 


t'^ 


CORPORATION  FINANCE 


J 

I 


cures  centralized  and  efficient  management,  is  apt  to 
prove  unsatisfactory  in  that  it  does  not  bring  into  play 
the  whole  selling  machinery  of  the  various  syndicate 
members.     For  this  reason  it  has  become  more  and  more 
customary  of  late  years  to  distribute  the  security  issue 
among  the  members  of  the  syndicate.     This  is  the  fifth 
type  of  an  underuriting  syndicate.     Strictly  speaking 
of  course,  the  distribution  of  securities  is  not  an  under- 
writmg  in  any  sense,  but  a  sale.     It  is  a  sale  at  a  special 
price,  however,  made  under  certain  restrictions  and  de- 
signed to  serve  exactly  the  same  purpose  as  true  under- 
writing;  the  term  therefore  is  freely  applied  to  it  in  the 
Street.     Chief  among  the  restrictions  on  the  sale  is  an 
agreement,  either  tacit  or  written,  that  the  securities 
shall  not  I)e  resold  to  the  public  at  less  than  a  certain 
fixed  price.    Frequently  it  is  also  agreed  that  some  one 
or  two  of  the  syndicate  members  shall  be  given  the  first 
opportunity  to  advertise  a  sale  of  the  securities,  and  that 
the  other  members  are  to  keep  out   )f  the  open  market 
for  a  limited  period.    Sucii  an  agreement  would  not  bar 
any  of  the  syndicate  members  from  selling  the  securities 
to  their  regular  clients. 

Among  the  members  of  a  syndicate  of  this  type  there 
are  frequently  several  individuals  and  institutions  who 
are  buying  the  securities,  not  for  resale,  but  for  invest- 
ment; they  are  simply  getting  on  the  ground  floor, 
making  their  investment  at  the  special  sj-ndicate  price. 
Readers  will  perhaps  recall  that  this'  practice  was 
brought  to  public  attention  and  much  discussed  during 
the  great  insurance  investigation  of  1904.  Mr.  George 
W.  Perkins,  later  of  the  firm  of  J.  P.  ^forgan  and  Com- 
pany, and  Mr.  James  IT.  Hyde,  among  others,  alleged 
that  their  participation  as  imlividuals  in  syndicates, 
which  was  disclose<l  during  the  investigation,  was  for  the 


THE  UNDERWRITING  SYNDICATE 


319 


purpose  of  buying  bonds  at  especially  low  prices  for  the 
insurance  companies  which  they  represented.  One  ob- 
jection to  allowing  investors  to  participate  in  syndicates 
of  this  type  is  that  they  may  decide  later  to  sell  the 
securities  allotted  to  them  before  the  banking  members 
of  the  syndicate  are  through  selling,  and  may  thereby 
break  the  price.  With  the  view  to  avoiding  such  a  re- 
sult syndicate  managers  are  exceedingly  careful  in 
choosing  members  who  buy  for  investment,  not  for  re- 
sale. 

108.  The  large  underwriting  houses  — The  Wall 
Street  Journal,  in  a  recent  article  dealing  with  the  prac- 
tice of  the  big  corporations  in  disposing  of  hond  issues 
to  underwriting  syndicates  of  the  third,  fourth  and  fifth 
types,  says: 

One  method  is  to  sell  the  bonds  in  a  block  to  one  of  the 
great  underwriters.  Pennsylvania,  Baltimore  and  Ohio,  Union 
Pacific,  and  many  others,  sell  direct  to  Kiihn,  Loeb  &  Company, 
pt  the  money,  and  thereafter  take  only  an  indirect  interest 
in  tlie  bonds.  Rock  Island  sells  to  Speyer  &  Company,  'Frisco 
to  Blair  &  Company  and  others.  New  York  Central,  Lake  Shore, 
Soutlitrn  Railway,  Eric  and  others  to  J.  P.  Morgan  &  Com- 
pany. The  price  at  which  these  railroads  sell  their  bonds  to 
tlic  underwriters  is  not  generally  known.  It  is  taken  to  be  a 
private  matter,  but  it  often  leaks  out. 

Another  method,  not  uncommon,  is  to  sell  the  bonds  to  the 
big  retail  bond  houses  who  distribute  them  to  a  wide  and  wealthy 
public  through  advertising  and  through  correspondence.  Each 
of  these  houses  has  its  clientele.  Some  are  strong  in  New  York, 
otiu  rs  in  Canada,  others  in  the  South,  etc.  They  are  more  or 
less  specialists,  and  get  to  be  known  for  a  particular  gradt  of 
lioiids  or  stocks. 

Tliiso  two  methods,  of  course,  ovrrhip  greatly.  Haivey  I'isk 
k  Scms,  for  instance,  known  for  years  nn  a  big  retail  bond  house 
of  wide  clientele,  frequently  underwrite  whole  issues  of  Becuri- 


320 


CORPORATION  FINANCE 


It    S 


If 


iri 


I 


! 


'!• 


tics,  as  in  the  case  of  the  Electrical  Securities  collaterals, 
recently  brought  out.  Similarly,  Fisk  &  Robinson  took  the 
whole  issue  of  the  new  Buffalo  &  Susquehanna  Railway  iY'S. 
J.  P.  Morgan  &  Company,  Kuhn,  Locb  &  Company  and  Speycr 
&  Company  generally  participate  to  a  greater  or  less  extent 
in  any  extensive  new  bond  issue,  because  their  clientele  demands 
it,  even  though  these  firms  may  not  be  the  original  underwriters. 

Summing  ui>  m  hat  has  been  said  with  regard  to  the 
various  types  of  underwriting  syndicates,  it  is  evident 
that  the  tendency  is  growing  for  the  corporation  to  sell 
its  new  security  issues  at  fixed  prices  to  the  large  bank- 
ing houses  and  then  wash  its  hands  of  the  business  of 
selling  the  securities.  Experience  has  demonstrated 
that  this  is  the  best  method  for  the  corporation.  Bank- 
ing houses  also  prefer  this  method  to  the  original  under- 
writing, which  consisted  simply  in  guaranteeing  the 
price,  for  two  reasons:  first,  because  they  can  thus  con- 
trol the  price  and  time  of  sale  and  bring  to  bear  their 
skill  in  selling;  second,  because  the  underwriters,  having 
full  control  of  the  securities,  can  post  them  as  collateral 
and  secure  bank  loans,  thereby  reducing  their  direct 
cash  obligations. 

In  making  this  last  statement  the  writer  has  in  mind 
the  distinction  between  "banking  houses"  and  "banks" 
which  may  not  be  familiar  to  all  readers.  "Banking 
houses,"  so-called,  seldom  carry  deposits  to  any  great 
extent  from  other  people,  and  do  not  make  a  business  of 
loaning  money.  Their  chief  interests  lie  in  buying  and 
selling  securities.  "Banks,"  on  the  other  hand,  draw 
their  profits  mainly  from  receiving  deposits  and  making 
loans. 


CHAPTER  XX 

THE  MANAGEMENT  OF  THE  UNDERWRITING 
SYNDICATE 

169.  Informal  agreements. — As  there  are  only  a  few 
large  banking  houses  and  institutions,  even  in  the  whole 
country,  which  ordinarily  take  part  in  large  underwrit- 
ing syndicates  and  as  these  houses  are  thoroughly  fa- 
miliar with  each  other's  policies  and  resources,  the  agree- 
ments among  them  are  frequently  quite  informal.  In 
one  large  transaction  recently,  as  was  later  brought  out 
on  the  witness  stand,  J.  P.  Morgan  and  Company 
formed  an  underwriting  syndicate  simply  by  allotting  a 
certain  proportion  of  the  security  issue  to  each  of  several 
large  firms  and  institutions.  The  members  of  the  syndi- 
cate were  not  consulted  at  all  or  even  advised  in  writing, 
but  were  merely  called  on  the  telephone  and  notified  of 
their  participation.  The  informality  was  possible  in 
this  case  because  the  sjrndicate  was  expected  to  make 
good  profits  and  J.  P.  Morgan  and  Company  well  knew 
that  everyone  concerned  would  gladly  take  as  large  an 
allotment  as  the  syndicate  managers  would  grant. 

170.  A  formal  syndicate  agreement. — Ordinarily, 
however,  a  formal  syndicate  agreement  is  drawn  up  and 
signed.  As  these  agreements  are  not  generally  made 
public,  their  exact  terms  seldom  become  known.  The 
most  elaborate  and  perhaps  the  most  important  agree- 
iiitnt  of  this  nature  that  has  been  given  out,  was  pro- 
duced on  the  witness  stand  in  the  famous  suit  to  prevent 
the  conversion  of  United  States  Steel  preferred  stock 
into  l)onds,  referred  to  in  Chapter  XV.    The  agreement 

c—vi— 21  821 


322 


CORPORATION  FINANCE 


is  of  such  interest  and  importance  that  it  is  given  in  full 
below : 

U.  S.  STEEL  CORPORATION  PREFERRED  STOCK  RE- 
TIREMENT SYNDICATE  AGREEMENT. 

An  ageeement  made  the  12th  day  of  March,  1902,  by  and 
between  J.  P.  Morgan  &  Co.,  co-partners,  as  Bankers,  of  the 
City  of  New  York,  parties  of  the  first  part,  and  the  sub- 
scribers hereto  (hereinafter  called  severally,  parties  of  the 
second  part). 

Wheeeas,  The  United  States  Steel  Corporation  (herein- 
after called  the  "Steel  Company")  proposes  to  make  with  J. 
P.  Morgan  &  Co.,  a  certain  contract  or  contracts  whereunder 
in  behalf  and  on  account  of  the  Steel  Company  they  are  to 
offer  to  all  of  the  preferred  stockholders  of  the  Steel  Company, 
severally  and  ratably,  the  preferential  opportunity  of  subscrib- 
ing for  and  of  taking  at  par  the  "Ten-Sixty  Year"  Five  Per 
Cent  Sinking  Fund  Gold  Bonds  of  the  Steel  Company  in  even 
amounts  approximately  equal  to  40  per  cent  of  their  several 
holdings  of  preferred  stock,  such  subscriptions  to  be  payable  in 
such  preferred  stock  at  par,  provided  that  every  such  subscrip- 
tion stockholder  at  the  time  of  such  original  subscription  pay- 
able in  preferred  stock  shall  have  the  right  of  his  option  then 
to  make  an  additional  subscription  payable  in  cash  for  such 
bonds  to  an  amount  equal  to  25  per  cent  of  his  stock  subscrip- 
tion; such  bonds  to  be  authorized  now  for  the  principal  sum  of 
$260,000,000  and 

Whereas,  In  and  by  such  contracts  J.  P.  Morgan  &  Co. 
are  to  guarantee  to  the  Steel  Company,  that  subscriptions  for 
such  bonds  will  be  made  for  the  aggregate  sum  of  at  least 
$100,000,000,  payable  in  i)rcferri'«l  stock  to  the  extent  of  four- 
fifths  of  said  sum,  and  in  cash  for  the  remaining  one-fiftli 
thereof;  such  contracts  to  provide  for  the  paynjent  or  allow- 
ance to  J.  P.  Morgan  k  Co.,  of  a  commiss'on  of  4  per  rent 
upon  the  aggregate  par  amount  of  all  such  bonds,  which  shall 
be  sold  and  delivered  under  their  said  offer,  or  to  them,  they 


SYNDICATE  MANAGEMENT 


323 


having  the  prior  right  to  take  all  of  such  bonds  which  shall  be 
ort'cml  for  subscription,  and  which  shall  not  be  taken  by  the 
preferred  stockholders  under  such  offer ;  and 

Whereas,  upon  the  terms  of  this  agreement,  and  for  the 
purposes  above  mentioned  all  of  the  parties  hereto  now  desire 
to  form  a  syndicate  to  provide  and  to  furnish  to  J.  P.  Morgan 
&  Co.  for  delivery  to  the  Steel  Company  the  preferred  stock, 
ami  the  cash  required  under  their  said  guaranty,  and  to  receive 
from  J.  P.  Morgan  &  Co.,  four-fifths  of  the  net  commissions  by 
them  received  under  the  said  contract  or  contracts  with  the 
Steel  Company,  which  contracts  J.  P.  Morgan  &  Co.  arc 
authorized  from  time  to  time  to  make,  modify  and  perform,  as 
in  the  exercise  of  their  unlimited  discretion  from  time  to  time 
they  may  deem  proper,  do  agree,  as  follows,  viz. : 

First.  On  signing  this  agreement  each  subscriber  has  de- 
livered to  J.  P.  Morgan  &  Co.  certificates  for  preferred  stock 
of  the  Steel  Company  in  the  amount  indicated  in  his  stock  sub- 
scription hereto,  which  preferred  stock,  to  such  extent  as  may 
1k'  required  to  meet  the  requirements  of  their  said  guaranty, 
is  to  be  delivered  to  the  Steel  Company  at  par  in  exchange  for 
the  Ten-Sixty  Year  Five  Per  Cent  Gold  Bonds  of  the  Steel 
Company  for  an  equal  amount  at  par,  to  be  received  therefor 
hy  any  subscriber,  and  any  such  preferred  stock  not  so  delivered 
to  the  Steel  Company  is  to  be  returned  to  the  subscribers  rata- 
l)ly  according  to  their  several  subscriptions. 

Second.  Each  subscriber  further  agrees  to  pay  J.  P.  Mor- 
gan Sc  Co.  in  cash  the  sum  specified  in  his  cash  subscription 
hereto,  for  which  cash  J.  P.  Morgan  &  Co.  shall  receive  from 
the  Steel  Company  bonds  as  aforesaid  at  par  equal  to  the 
amount  of  such  cash  payment  by  such  subscribers. 

Tiiuin.  The  several  deliveries  and  undertakings  of  the 
several  subscribers  under  this  agrcenient  shall  be  made  and  per- 
formed hy  tiie  subscribers  respectively  when  and  as  requested 
I'.v  J.  1',  Morgan  k  Co.  or  by  the  subscribers,  of  any  of  said 
I  i\e  IVr  Cent  Sinking  Fund  Gold  Bonds  of  the  Steel  Company. 

I'oriiTit.     The  several  subscribers  shall  be  called  upon  to 


ir 


324 


CORPORATION  FINANCE 


■  : 


i 


make  payments  of  cash  in  respect  of  their  several  subscriptions 
only  ratably  according  to  the  several  amounts  thereof;  but  each 
subscriber  shall  be  so  responsible  to  the  full  extent  of  the  sev- 
eral undertakings  regardless  of  performance  or  non-perform- 
ance by  any  other  subscriber.  In  the  same  proportion  except 
as  otherwise  provided  the  several  subscribers  shall  be  responsible 
for  loss  resulting  to  the  Syndicate  under  this  agreement.  Noth- 
ing herein  contained  shall  constitute  the  parties  hereto  partners, 
or  shall  render  any  of  the  subscribers  liable  to  contribute  more 
than  his  several  proportionate  amount  as  herein  provided. 

Fifth.  In  the  case  of  the  failure  of  any  subscriber  to 
perform  any  of  his  undertakings  hereunder  as  and  when  called 
for  by  them,  J.  P.  Morgan  &  Co.  in  behalf  of  themselves  and 
the  syndicate  shall  have,  and  at  their  sole  and  exclusive  option 
they  may  exercise,  the  right  to  exclude  such  subscriber  from 
all  interest  in  the  Syndicate,  and  in  their  discretion,  without 
any  proceedings,  either  at  law  or  in  equity,  they  may  dispose 
of  such  subscriber's  participation  hereunder  of  any  interest 
or  right  of  such  subscriber  hereunder  or  under  any  of  said 
proposed  contracts,  but  nevertheless,  each  subscriber  in  default 
shall  be  responsible  to  J.  P.  Morgan  &  Co.  for  the  benefit  of 
themselves  and  the  other  subscribers  hereto  for  all  damages 
caused  by  any  failure  on  his  part.  At  any  public  sale  under 
this  article  of  any  interest  or  right  of  any  subscriber  J.  P. 
Morgan  &  Co.  or  any  party  thereto  may  become  purchaser 
for  their  own  or  for  his  own  benefit,  without  accountability ;  but 
notwithstanding  any  sale,  whether  public  or  private,  the  de- 
faulting subscriber  shall  be  responsible  to  J.  P.  Morgan  &  Co. 
and  to  the  Syndicate  for  all  damages  caused  by  such  failure  on 
his  part. 

Sixth.  J.  P.  Morgan  &  Co.  shall  have  full  power  in  their 
discretion  from  time  to  time,  to  agree  with  the  Steel  Company 
upon  the  terms  and  provisions  of  any  contracts  such  as  are 
above  referred  to;  and  also,  from  time  to  time,  to  enter  into 
any  agreements  with  the  Steel  Company  modifying  the  said 
contracts  as  they  may  deem  expedient.    They  may  deliver  to 


SYNDICATE  MANAGEMENT 


325 


till'  Stiul  Company  a  copy  of  this  agreement,  having  annexed 
tlarito  a  list  of  the  subscribers;  and  thereupon  to  the  extent 
of  tlitir  several  subscriptions,  the  subscribers,  severally  and 
respectively,  but  not  jointly,  and  no  one  for  any  other,  shall 
become  responsible  for  the  performance  of  such  contracts  with 
the  Stcei  Company  in  discharge  of  the  obligations  thereunder 
of  J.  P.  Morgan  &  Co.  Any  and  all  contracts  with  the  Steel 
Company  made  by  J.  P.  Morgan  &  Co.  shall  be  open  to  in- 
spection by  any  subscriber  at  the  office  of  J.  P.  Morgan  &  Co. 

Seventh.  J.  P.  Morgan  &  Co.  shall  be  the  sole  and  final 
judges  as  to  whether  at  any  time  it  is  to  the  interest  of  the 
Syndicate  to  proceed  further  under  this  agreement  or  under 
said  proposed  contracts;  and  wherever  they  may  deem  ex- 
pedient, they  may  abandon  the  objects  contemplated,  in  this 
agreement  and  said  proposed  contracts  and  all  further  pro- 
ceedings thereunder.  In  such  event  all  the  cash  or  stock  and 
bonds  by  them  received  and  then  held  for  account  of  the  Syndi- 
cate, and  the  proceeds  of  such  stock  and  bonds  shall  remain 
charged  with  the  payment  of  all  expenses  and  liability  by  them 
incurred  hereunder  and  shall  be  applied: — 

First  to  the  payment  of  any  and  all  expenses  and  obligations 
incurred  by  J.  P.  Morgan  &  Co.  under  any  provisions  of  this 
agreement. 

Secondly,  in  repayment  to  the  subscribers  (so  far  as  the 
same  may  be  sufficient  for  that  purpose)  of  all  amounts  of 
preferred  stock  or  of  cash  by  them  respectively  delivered  here- 
under to  J.  P.  Morgan  &  Co.,  such  repayment  to  be  made  to 
the  subscribers  ratably. 

Eighth.  J.  P.  Morgan  &  Co,  shall  be  sole  managers  of 
the  Syndicate,  and  in  behalf  of  the  Syndicate  they  may  make 
any  and  all  arrangements,  and  may  perform  any  and  all  acts, 
even  though  not  herein  provided  for,  in  their  opinion  necessary 
or  expedient  to  carry  out  the  purposes  of  this  agreement,  or 
to  promote  or  to  protect  what  they  deem  to  be  the  best  interests 
of  the  Syndicate. 

Tlie  enumeration  of  specific  powers  in  this  or  in  any  other 
article  of  this  agreement  shall  not  be  construed  as  in  any  way 


*j2r> 


rOHI'ORATION  FINANCi: 


t  .. 


'  I 


j 


f 


abridging  the  general  powers  of  this  article  intended  to  be  con- 
ferred upon  or  reserved  to  J.  P.  Morgan  &  Co. 

Ninth.  From  tii<ir  to  time  before  October  1,  1903,  J.  p. 
Morgan  &  Co.  in  behalf  of  the  Syndicate,  may  make  sales  of  all 
or  any  part  of  the  bonds  received  bj  them  for  account  of  the 
Syndicate.  Any  such  sales  may  be  made  by  J,  P.  Morgan  & 
Co.  cither  publicly  or  privately,  by  themselves,  or  in  such  man- 
ner as  they  may  deem  proper,  and  shall  be  upon  such  terms  and 
for  such  price  or  prices  as  they  may  deem  expedient.  Each 
subscriber  hereby  assents  to,  and  agrees  to  be  bound  by  an>' 
such  action. 

No  subscriber  shall  be  entitled  to  receive  any  of  said  bonds 
before  October  1,  1903.  In  the  meantime,  in  their  discretion, 
J.  P.  Morgan  &  Co.  either  themselves  nmy  retain  all  or  anv 
part  of  such  bonds,  or  they  may  deliver  to  any  subscriber  his 
proportionate  part  thereof,  upon  his  agreenunt  to  hold  the 
same  subject  to  sale  by  J.  P.  Morgan  &  Co.  and  to  return  the 
same  upon  call  of  J.  P.  Morgan  &  Co.  at  any  time  before 
October  1,1903. 

Should  any  subscriber  desire  to  withdraw  from  sale  the  por- 
tion of  bonds  to  which  he  may  be  entitled  hereunder,  J.  P. 
Morgan  &  Co.,  in  tluir  discretion  may  deliver  to  any  sub- 
scriber his  portion  of  such  bonds  upon  his  agreement  to  hold 
the  same  for  himself  without  sale  until  October  1,  1903,  or  until 
the  complete  sale  by  J.  P.  Morgan  &  Co.  at  an  earlier  date  of 
all  bonds  held  by  or  for  the  Syndicate. 

Tenth.  Until  October  1,  1903,  or  until  the  final  distribu- 
tion hereunder,  J.  P.  Morgan  k  Co.  in  such  manner,  at  such 
prices,  on  such  terms,  and  in  such  amounts  as  they  may  deem 
expedient,  shall  have  power  for  account  of  the  Syndicate,  to 
make  purchases  of  the  5  per  cent  gold  bonds  and  of  the  pre- 
ferred stock  of  the  Steel  Company,  and  they  may  resell  any 
such  bonds  and  stocks  which  they  may  have  purchased  and  in 
their  discretion  they  may  make  any  further  undertakings  of 
any  kind  with  any  persons  concerning  any  such  bonds  and 
stocks.     They  may  apply  towards  any  such  purchasers  any 


SYNDICATE  MANAGEMENT 


32; 


sums  realized  from  any  sales  of  bonds  and  stocks  of  the  Steel 
(oinpimy  under  any  provisions  of  this  agreement;  and  they 
iiiav  make  advances,  or  may  procure  loans,  and  may  secure  the 
MiiiK'  to  such  amounts  and  in  such  manner  as  from  time  to  time 
lluv  may  deem  expedient  for  any  of  the  purposes  of  this 
agrt'fiiiont. 

Em.vk.nth.  J.  P.  Morgan  &  Co.  shall  issue  to  the  subscribers 
suitable  receipts  in  respect  of  payments  made  hereunder,  and 
thev  may  issue  to  the  respective  subscribers  certificates  of 
intcri'st  of  such  tenor  and  form  as  they  may  deem  suitable. 
Such  certificates  of  interest  and  rights  and  obligations  here- 
under of  the  respective  subscribers  may  be  made  transferable 
in  such  manner  and  on  such  terms  and  conditions  as  J.  P.  Mor- 
gan &  Co.  may  prescribe. 

Twelfth.  J.  P.  Morgan  &  Co.  shall  have  authority  from 
time  to  time  and  at  any  time  to  incur  such  expenses  as  they 
may  deem  proper  in  carrying  out,  or  endeavoring  to  carry 
out,  this  agreement  or  said  proposed  contracts,  or  in  doing 
any  act  or  thing  which  they  may  deem  to  be  in  the  interest  of 
tlic  Syndicate,  and  all  such  expenses  shall  constitute  and  be  a 
prior  charge  in  their  favor  upon  any  and  all  money's,  stocks 
and  bonds  by  them  received  hereunder  shall  hold  by  them  as 
bankers  in  general  account.  They  also  shall  have  power  and 
authority,  in  their  sole  and  absolute  direction,  finally  to  fix  and 
pay  all  compensations  or  depositaries,  brokers,  agents  and 
counsel,  or  others,  and  in  the  expense  account  may  be  included 
brokers'  commissions  as  usually  paid. 

Tmikteenth.  After  the  complete  performance  of  the  entire 
oblifration  of  the  Syndicate  hereunder,  but  not  before  the  first 
flay  of  October,  1903,  unless  otherwise  determined  by  J.  P. 
Morgan  &  Co.,  in  the  exercise  of  their  unrestricted  discretion, 
j)iiymeiit  may  be  made  to  the  Syndicate  by  J.  P.  Morgan  & 
Co.  for  the  purpose  of  this  agreement,  out  of  any  moneys  for 
.>ucli  j)urposes  received  or  retained  by  J.  P.  Morgan  &  Co. 

ForRTEENTH.  J.  P.  Morgan  &  Co.  shall  not  be  liable  under 
any  of  the  provisions  of  this  agreement  nor  for  any  matter 


828 


CORPORATION  FIXANCE 


therewith  connected  except  for  good  faith  in  performing  or 
in  refraining  from  performing  or  carrying  out,  the  obligations 
by  them  herein  expressly  assumed;  the  implication  of  anv 
obligation  not  herein  expressly  assumed  by  them  being  hereby 
expressly  denied  and  waived. 

It  is  understood  that,  in  the  same  manner  as  other  subscrib- 
ers, J.  P.  Morgan  &  Cr>.  may  become  subscribers  hereto,  that 
as  such  subscribers  they  shall  be  liable  for  all  subscriptions  by 
them  made,  and  that  in  all  respects  they  shall  be  entitled  to  the 
same  rights  and  benefits  as  any  other  subscriber.  Any  sub- 
scriber hereto  may,  on  his  own  account,  make  any  agreement 
with  any  other  subscriber  or  with  the  Steel  Company. 

Fifteenth.  This  agreement  shall  bind,  and  is  for  the 
benefit  of  the  parties  hereto  and  their  administrators  and  execu- 
tors, severally  and  respectively,  but  no  assignment  hereunder 
shall  be  valid  unless  assented  to  in  writing  by  J.  P.  Morgan 
&  Co. 

All  rights  and  powers  J.  P.  IVIorgan  &  Co.  hereunder  shall 
vest  in  said  co-partnership  firm,  as  from  time  to  time  consti- 
tuted, without  further  act  or  assignment. 

Sixteenth.  Nothing  herein  contained  shall  be  construed 
as  creating  any  trust  or  obligation  whatsoever  in  favor  of 
any  person  or  corporation  other  than  the  subscribers,  nor  any 
obligation  in  favor  of  the  subscribers  excepting  only  as  herein 
is  expressly  provided. 

Seventeexth.  Each  subscriber  shall  set  opposite  his  sub- 
scription hereunder  an  address,  to  which  notices,  calls  or  other 
communications  may  be  sent,  and  any  notice,  call  or  other 
communication  addressed  to  any  subscriber  at  the  address  so 
given,  and  either  at  such  address  or  mailed,  shall  be  deemed 
actually  given  to  such  subscriber,  and  shall  be  sufficient  for  all 
the  purposes  hereof.  If  any  subscriber  shall  fail  so  to  furnish 
an  address  to  J.  P.  Morgan  &  Co.,  he  shall  not  be  entitled  to 
any  notice  of  calls  or  offers,  or  any  other  notice  hereunder,  and 
he  shall  be  deemed  to  assent  to  any  action  of  J.  P.  Morgan  &  Co. 

Eighteexth.  In  consideration  of  the  irrevocable  rights 
in  them  vested  hereunder  and  the  promises  of  the  several  sub- 


SYNDICATi    ...     ^TAGEMENT 


329 


scribe rs,  J.  P.  Morgan  &  Co.  have  become  parties  to,  and 
in  good  faitli  will  endeavor  to  consummate  the  purposes  of 
this  agreement ;  and,  after  receipt  thereof  from  the  Steel  Com- 
{mnv,  they  will,  as  herein  provided,  deliver  to  the  Syndicate 
the  said  Five  Per  Cent  Gold  Bonds,  or  the  proceeds  thereof, 
and  the  said  cash  compensation. 

Ix  WITNESS  WHEREOF,  the  parties  of  the  first  part  have 
hircunto  affixed  their  signatures,  and  the  parties  of  the  second 
part  at  various  dates  have  affixed  their  subscriptions  hereto, 
it  being  understood  that  for  convenience  this  agreement  may 
be  subscribed  in  several  parts  and  copies  with  the  same  force 
and  effect  as  if  all  the  subscriptions  were  on  one  part  or  copy 
thereof. 

SUBSCRIPTION   FOR  FIVE  PER  CENT  GOLD   BONDS 
Name  Address  Preferred  Stock  Cash 

171.  Characteristics  of  syndicate  agreements. — The 
most  prominent  feature  of  this  agreement,  as  the  reader 
has  no  doubt  observed,  is  the  absohite  and  unrestricted 
authority  retained  by  the  managers  of  the  syndicate. 
Such  phrases  as  "J.  P.  Alorgan  &  Company  shall  have 
full  power  in  their  discretion,"  "J.  P.  Morgan  &  Com- 
pany shall  be  the  sole  and  final  judges,"  "J.  P.  Morgan 
k  Company  shall  have  authority  from  time  to  time  and 
at  any  time,"  "J.  P.  Morgan  &  Company,  in  the  exer- 
cise of  their  unrestricted  discretion,"  and  so  on,  abound. 
In  this  respect  the  agreement  is  typical  of  all  underwrit- 
ing' syndicates.  Indeed,  it  is  easy  to  see  that  without 
such  unrestricted  authority  the  syndicate  managers 
could  not  carry  on  their  operations  with  the  necessary 
promptness  and  secrecy.  The  real  check  to  any  abuse 
of  this  power  is  to  be  found  in  the  necessity  resting  on 
each  banking  firm  to  preserve  its  reputation  for  integ- 
rity absolutely  unstained. 

For  the  same  reason  this  agreement,  like  most  other 


330 


CORPORATION  FINANCE 


I 


H 


■ 


such  agreements,  is  marked  hy  „pen  dealing,  so  far  as 
the  essential  things  are  concerned.  At  the  very  begin 
ning  of  the  agreement  J.  P.  Morgan  and  Company 
state  the  commission  which  they  are  to  receive.  There 
IS  nothing  «m  their  part  concealed  from  the  other 
syndicate  members;  they  state  clearly  what  their  profits 
and  what  the  profits  of  each  member  are  to  be.  The 
same  rule  holds  true  even  in  cases  where  the  original 
underwriter  is  to  make  an  extra  profit  over  and  above 
what  goes  to  the  other  sjnidicate  members.  Secret  prof- 
its are  not  permissible  under  the  code  of  ethics  that 
governs  underwriting  transactions. 

Sometimes  it  hai)pens  that  one  of  the  underwriting 
firms  finds  its  allotmcnls  too  large  for  some  reason,  in 
which  case  it  will  probably  form  a  sub-svndicate.  The 
members  of  the  sub-syndicate  are  usually  individuals  or 
smaller  banking  firms.  They  are  not  brought  into  con- 
tact at  all  with  the  original  syno  ite  and  have  no  part 
m  its  workings,  but  are  responsible  solely  to  the  other 
members  of  the  sub-sj-ndicate. 

172.  Functions  of  underwriting  syndicates.— UnAtr- 
writing  syndicates  may  handle  the  securities  of 

(a)  Established  corporations. 

(b)  Reorganized  corporations. 

(c)  New  corporations. 

The  first  case  is  the  one  that  has  been  kept  in  view  so  far 
in  this  discussicm  and  need  not  be  further  considered. 
The  second  case  presents  some  points  of  difference  which 
will  be  referred  to  in  the  chapters  dealing  with  reor- 
ganization. In  both  cases  the  sjTi(hcate  is  handling  in- 
vestment securities  and  its  sole  problem  is  to  market 
those  securities  to  the  best  advantage.  The  third  case 
is  closely  allied  with  promotion;  the  syndicate  methods 
m  this  case  recpure  some  further  consideration. 


SYNDICATE  MANAGEMENT 


331 


173.  Underwriting  speculative  securities. — The  se- 
curities of  a  new  corporation,  no  matter  how  brilliant 
its  prospects  may  be,  are  almost  always  speculative;  the 
only  exception  is  when  a  new  corporation  is  formed  to 
take  over  a  business  already  established,  and  this  excep- 
tion we  need  not  consider  here.  The  first  distinction, 
tlidi,  between  a  syndicate  formed  to  underwrite  the  se- 
curities of  a  new  corporation  and  other  syndicates  is  that 
it  is  iiandling  stocks  and  bonds  of  doubtful  value  which 
it  cannot  recommend  unreservedly. 

A  second  distinction  is  that  the  syndicate  must  be 
prepared  to  put  up  more  cash  or  furnish  more  credit  in 
proportion  to  the  size  of  the  security  issues  than  would 
ordinarily  be  necessary.  This  follows  from  the  fact 
tliat  conservative  banks  are  not  willing  to  lend  much 
iiKinty  on  speculative  stocks  and  bonds. 

A  third  distinction  is  that  the  syndicate  must  be  pre- 
pared to  carry  the  proposition  through  to  the  end;  in  no 
other  way  except  at  an  enormous  sacrifice  can  the  money 
needs  of  the  new  corporation  be  met. 

A  fourth  distinction  lies  in  the  fact  that  for  their  own 
protection  the  syndicate  members  must  build  up  and 
maintain  the  credit  of  the  new  corporation. 

Evidently  there  are  several  difficult  and  dangerous 
problems  here  to  be  solved.  It  is  essential  to  their  so- 
lution that  the  syndicate  should  absolutely  control  the 
new  corporation.  Without  control  measures  may  be 
taken  that  will  impair  the  credit  of  the  corporations  and 
f»rinp  heavy  losses  upon  the  syndicate.  Even  with  full 
control  such  enterprises  are  usually  deemed  too  risky  to 
f»e  participated  in  by  banking  houses  of  the  best  class. 
At  least  if  such  houses  do  enter  the  syndicate  they  accept 
orily  small  allotments,  knowing  full  well  the  danger  of 
becoming  more  deeply  involved  as  the  enterprise  pro- 


; 


332 


CORPORATION  FINANCE 


tup 

1  '' 
^'    I 


^1 


! 


5 

I 


ceeds.     No  one  can  teU  in  advance  what  the  cash  re- 
quirements of  a  new  corporation  may  be 

Each  enterprise  of  this  nature  has' its  own  variations 
ot  the  difficulties  and  dangers  that  have  been  cited  and 
requires  a  solution  that  will  exactly  fit  its  own  peculiar- 
ities  Perhaps  the  ber*  way  of  explaining  the  usual 
solution  will  be  to  present  the  facts  of  a  particular  in- 
stance with  which  the  writer  happens  to  be  familiar. 

174.  An  example  of  speculative  underwriting. -In 
the  spring  of  1902  the  promoter  of  a  smelting  and  re- 
fining  company  in  Mexico  succeeded  in  convincing  a 
number  of  Philadelphia  financiers  that  his  proposition 
was  worth  looking  into.  They  made  a  thorough  investi- 
gation, satisfied  themselves  that  the  proposed  plant 
would  certainly  prove  profitable,  and  undertook  to 
finance  its  construction.  Engineers'  estimates  called  for 
an  expenditure  of  something  over  $2,000,000  and  a 
period  of  three  years  before  the  plant  would  begin  to 
earn  expenses.  As  a  matter  of  fact,  the  expenditure 
was  approximately  $8,000,000  and  the  construction  work 
was  not  completed  until  early  in  1907. 

A  syndicate  of  Philadelphia  and  Baltimore  capital- 
ists and  banking  houses  was  formed  to  underwrite  the 
enterprise.  Next  an  entirely  different  sjTidicate  of 
banking  houses  was  organized,  which  agreed  to  take  the 
notes  when  issued  up  to  a  certain  amount  of  syndicate 
No.  I,  the  notes  to  be  secured  by  the  stock  of  a  corpora- 
tion organized  to  construct  the  plant.  The  corporation 
was  capitalized  at  $2,000,000.  half  preferred  and  half 
common  stock.  All  its  stock  was  sold  to  s>'ndicate  Xo. 
I.  for  $1,000,000.  Syndicate  No.  I  then  posted  the 
stock  and  gave  notes  to  svTidicate  No.  TT.  which  loaned 
the  $1,000,000.  Thus  syndicate  No.  I  was  not  called 
upon  for  cash,  except  for  expenses,  and  the  construction 


SYNDICATE  MANAGEMExNT 


333 


company  was  supplied  with  $1,000,000  with  which  to 
begin  operations. 

Next,  after  expending  the  $1,000,000,  the  construc- 
tion company  issued  $500,000  of  its  own  notes,  which 
being  its  only  obligations  were  accepted  by  Philadelphia 
banks.     The  discount  on  this  and  the  other  sales,  for  the 
sake  of  simplicity,  we  will  eliminate.     Up  to  this  point 
one-half  the  necessary  funds  had  been  secured  and  at  the 
end  of  two  years  the  work  of  construction  had  been  more 
than  half  completed.     Now  a  new  corporation  was 
formed  which  was  to  operate  the  plant.     The  reader  will 
obs  '  e  that  the  first  corporation  existed  simply  to  carry 
on  construction.     The  operating  corporation  at  once 
took  over  the  stock  of  the  construction  company,  title  to 
which  up  to  this  time  had  remained  with  syndicate  No.  I. 
Then  the  operating  corporation  put  out  a  first-mortgage 
bond  issue,  based  on  all  its  property  then  owned  and 
thereafter  to  be  constructed,  and  sold  during  the  next 
two  years  $1,500,000  bonds.     In  this  way  the  whole 
$3,000,000  necessary  to  built  the  plant  was  raised  by 
borrowing  and  the  members  of  syndicate  No.  I  furnished 
nothing  to  the  enterprise  but  tlieir  credit.     The  diagram 
on  page  334  will  perhaps  assist  the  reader  in  arriving  at 
a  clear  understanding  of  the  whole  series  of  transactions. 
The  plant  at  the  date  of  writing  has  been  running  a 
little  over  two  years.    Earnings  have  been  more  than 
siitticient  to  meet  all  interest  charges  and  other  expenses, 
and  it  is  expected  that  larp<  profits  will  be  earned  in  the 
future.     Although  the  enterprise  is  not  yet  beyond  the 
speculative  stage,  its  chief  difficulties  have  l>een  over- 
come and  its  prospects  appear  bright.     The  first  use  to 
which  surplus  earnings  will  l)e  devoted,  according  to  the 
present  plans,  will  be  the  paying  off  of  the  $1,000,000 
of  notes  issued  by  syndicate  No.  I,  and  of  the  $500,000 


1 


334 


CORPORATION  FINANCE 


1^ 


1 


SYNDICATE  MANAGEMENT 


335 


notes  of  the  construction  company.  As  soon  as  these 
obligations  are  met  the  construction  company  may  be 
dissolved  and  the  operating  company  will  begin  to  pay, 
it  is  expected,  big  dividends. 

It  may  seem  strange  that  a  new  plant  could  thus  be 
constructed  wholly  with  borrowed  funds;  yet  there  is 
nothing  especially  unusual  about  the  operation.  The 
secret  of  the  success  of  the  syndicate  in  this  instance  lay 
in  the  fact  that  they  were  themselves  strong  financially 
and  could  borrow  the  first  $1,000,000  readily.  This 
left  a  margin  of  safety  to  those  who  loaned  funds  di- 
rectly to  the  two  corporations.  Furthermore,  the  sj^- 
dicate  members  were  shrewd  and  prudent  enough  not  to 
use  up  all  the  available  credit  of  their  corporations  at 
the  heginning.  On  the  contrary,  the  essential  feature  of 
their  plan  of  operation  was  to  leave  the  best  lien  till  the 
last.  Thus  they  were  able  to  borrow  $1,500,000  on  first 
mortgage  bonds  at  a  time  when  most  corporations  under 
ordinary  management  would  have  been  compelled  to  call 
on  their  stockholders  for  funds. 

Much  more  complicated  instances  might  have  been 
cited.  The  principles  followed  in  all  those  that  have 
proved  successful,  however,  have  l)een  the  same,  namely: 
utilize  the  credit  of  the  backers  of  the  corporation  at  the 
beginning  and  save  the  best  security  that  the  corporation 
can  offer  till  the  end.  Working  in  this  way,  the  under- 
writing syndicates  of  new  corporations  frequently  bor- 
row large  sums  on  advantageous  terms. 


CHAPTER  XXI 


;lf 


INVESTMENT  OF  CAPITAL  FUNDS 

175.  The  importance  of  tcise  investment. — The  next 
question  that  confronts  the  promoter  or  manager  of  a 
new  corporation  after  he  has  succeeded  by  one  means  or 
another  in  raising  the  necessary  funds  is,  How  shall 
those  funds  be  invested?  This  seems  a  very  easy  prob- 
lem at  first  sight;  and  indeed  the  simple  process  of  in- 
vesting is  easy  enough.  To  invest  capital  funds  wisely 
and  to  the  best  advantage  for  the  future  of  the  corpora- 
tion, however,  is  a  task  that  requires  careful  thought  and 
foresight.  A  great  many  mistakes  are  made  just  at 
this  point.  The  causes  of  failure  of  a  great  many 
failed  corporations  may  be  traced  back  unquestionably 
to  errors  in  the  original  investment. 

Of  course,  each  corporation  has  its  own  peculiar  con- 
ditions to  meet  and  no  general  principles  can  be  laid 
down  that  will  take  the  place  of  keen  observation  and 
careful  reflection  over  all  factors  in  the  particular  situa- 
tion that  each  manager  faces.  Xevertheless,  there  are 
some  principles  with  regard  to  investment  of  capital 
funds  so  universal  and  some  fatal  errors  so  common  that 
a  short  study  of  the  problem  is  evidently  worth  while. 
Even  if  the  result  of  this  study  is  only  a  series  of  gener- 
alities, still  experience  shows  that  these  generalities  are 
worth  making  and  worth  keeping  constantly  in  view. 

170.  The  installment  method  of  getting  canh  ai 
needed. — Tn  the  first  place,  a  new  corporation  as  a  rule 
does  not  require  all  of  the  capital  funds  that  will  be  nee* 

836 


INVESTMENT  OF  CAPITAL  FUNDS 


337 


essary  lor  its  development  at  the  outset.  On  the  other 
side,  as  we  emphasized  in  connection  with  the  subject 
of  promotion,  the  corporation  managers  should  have  in 
siglit  from  the  very  beginning  all  the  capital  funds  that 
they  are  likely  to  need ;  for  an  effort  to  raise  additional 
cajjital  for  an  enterprise  that  is  only  half  or  two-thirds 
completed,  and  not  on  a  paying  basis,  is  painful  and  fre- 
quently unavailing.  The  manager  or  promoter  of  the 
♦  corporation,  then,  looks  for  some  method  of  reconciling 
these  conflicting  requirements. 

The  simplest  and  best  method,  from  the  corporation's 
standpoint,  is  to  obtain  subscriptions  before  the  new 
concern  is  started  for  more  than  enough  stocks  and  bonds 
to  carr>'  it  through  to  success,  but  to  have  the  cash  for 
these  securities  payable  in  installments.  This  method  is 
common  and  works  very  well  with  enterprises,  the  total 
capital  cost  of  which  can  be  accurately  estimated  in  ad- 
vance— such  enterprises,  for  instance,  as  the  erection  of 
an  office  building  or  the  construction  of  a  railroad.  In 
such  cases  the  installments  may  be  certain  definite  per- 
centages due  at  days  fixed  in  advance,  say  10  per  cent 
when  the  corporation  is  organized,  !^5  per  cent  at  the 
expiration  of  three  months,  25  per  cent  at  the  end  of  six 
months,  20  per  cent  at  the  end  of  nine  months,  and  the 
remaining  20  per  cent  at  the  end  of  a  year.  Ir*  this  way 
the  sale  of  securities  is  facilitated,  because  buyers  prefer 
tisiially  to  pay  in  installments,  and  the  corporation  gets 
its  funds  as  needed. 

The  case  is  quite  different,  however,  when  the  total 
nmnnnt  of  capital  funds  needed  cannot  be  foretold.  A 
corporation  may  be  formed,  for  instance,  to  open  up  a 
mine  or  construct  a  tunnel  or  start  a  magazine.  No- 
hndy  can  foresee  absolutely  what  obstacles  the  under- 
ground work  of  the  mine  or  tunnel  will  encounter,  or 

(—VI— 22 


«VIK^ 


838 


COlil'OUATiON  FINANCE 


h 


I 


how  quickly  the  magazine  will  "take"  with  the  reading 
public.  The  promoter  of  such  an  enterprise,  if  he  is 
honest  with  himself,  will  recognize  that  the  corporation 
perhaps  may  need  less  and  probably  will  need  a  great 
deal  more  capital  funds  than  he  anticipates.  In  order 
to  meet  this  situation  he  will,  if  he  can,  induce  people  to 
subscribe  capital  funds  to  an  amount  greater  than  will 
probably  be  needed,  issue  part-paid  stock  when  install- 
ments to  a  certain  amount,  say  50  per  cent,  have  been « 
paid  and  make  the  rest  of  the  installments  payable  at 
the  option  of  the  corporation.  Thus  the  corporation 
can  get  all  the  funds  it  needs  and  at  the  same  time  does 
not  have  to  carry  large  sums  for  which  it  has  no  partic- 
ular use.  This  is  the  ideal  arrangement  for  such  a 
corporation. 

177.  Disadvantages  of  this  method.— UnfoTtunniely 
this  plan  does  not  appeal  to  the  average  stockholder. 
He  does  not  like  the  idea  of  being  liable  at  all  times  for 
the  unpaid  installments,  particularly  as  the  calls  for 
additional  payments  in  many  such  enterprises  are  apt  to 
come  during  periods  of  financial  distress  at  the  very 
time  when  it  will  be  extremely  disagreeable  for  him  to 
meet  them.  Moreover,  in  large  corporations  such  an 
arrangement  gives  to  the  managers  of  the  corporation 
an  opportunity  for  manipulation  that  they  are  not  al- 
ways virtuous  enough  to  resist.  Take  the  case,  for  ex- 
ample, of  a  well-known  street  railway  company,  which 
may  be  recognized  by  some  of  our  readers,  but  whose 
name  it  would  be  improper  to  give  in  this  connection: 
This  company  has  a  very  large  amount  of  part-paid 
stock  outstanding,  the  remaining  installments  being  due 
and  payable  at  the  Oj>tion  of  the  board  of  directors.  It 
is  strongly  suspected  that  the  board  on  several  (Kicasions 
have  agreed  among  themselves  in  advance  to  issue  a  call 


I^^  ESTMExNT  OF  CAPITAL  FUNDS 


339 


for  ail  installment  and  have  thus  given  themselves  plenty 
of  time  to  aceumulate  casii.     Then  the  eall  has  been 
issued  and  the  installment  made  payable  at  a  very  early 
date,  so  as  to  make  it  difficult  for  most  of  the  stock- 
holders to  meet  the  call.     The  result  naturally  has  been 
in  each  instance  that  considerable  amounts  of  the  part- 
paid  stock  were  thrown  on  the  market  and  bought  up  at 
bar<?ain  prices  by  the  directors  and  their  friends.     With 
the  funds  received  from  the  installments  the  corporation 
'.as  been  in  position  to  put  its  property  in  good  condition 
and  show  excellent  earnings  for  a  year  or  two,  thus  al- 
hwinfr  the  directors  to  sell  stock  at  high  prices.     After 
it  was  distributed  the  directors  have  issued  another  call 
and  have  repeated  the  milking  process.     Experiences 
hke  this  have  made  buyers  of  securities  very  cautious  in 
the  purchase  of  part-paid  stock.     Generally  speaking,  it 
is  a  difficult  thing  to  sell  any  stock  that  is  not  labeled 
"full  paid  and  non-assessable." 

178.  Other  possible  methods.— It  follows  that  the 
mana<r(  rs  of  a  corporation,  the  needs  of  which  for  capi- 
tal funds  cannot  be  estimated  in  advance,  are  driven  to 
take  one  of  two  courses:  either  they  must  sell  at  the  be- 
ginning a  far  greater  amoimt  of  securities  than  will 
pn.hahly  prove  necessary,  and  put  their  idle  fund  to 
some  use  outside  the  original  purpose  of  the  corporation, 
or  I  Ise  they  must  tnist  to  luck  that  they  will  be  able  to 
sell  more  securities  when  additional  capital  funds  are 
needed.  Neither  one  of  these  alternatives  is  free  from 
serious  objections. 

TTere,  then,  is  the  first  great  problem  in  connection 
with  IJR.  investment  of  capital  funds,  that  of  getting  the 
riiiKis  when  and  if  they  prove  to  be  needed.  If  that 
j>rol)Iem  is  not  solved  in  just  the  right  manner,  either 
the  corporation  will  have  more  funds  on  hand  than  it 


340 


CORPORATION  FINANCE 


needs  and  its  rate  of  profits  on  stock  will  therobv  be 
diminished,  or  else  it  will  not  have  enough  funds  and  ib 
development  wUl  thereby  be  checked. 

179.  How  much  shall  be  invested  in  fixed  capitalf- 
The  next  questior  to  consider  is.  What  proportion  of  the 
capital  funds  shall  be  put  into  "fixed"  and  what  into 
working     capital?    The  distinctions   between  fixed, 
semi-fixed   current  and  quick  assets  were  discussed  in 
Chapter   VII.     The  fixed  and   semi-fixed   .  ssets  to- 
gether-those  assets,  in  other  words,  which  cannot  be 
readily  converted  into  cash-constitute  the  corporation's 
fixed  capital.     Working  capital  is  somewhat  different 
It  consists,  not  of  the  current  assets,  brt  of  the  differ- 
ence between  current  assets  and  current  obligations.   In 
other  words,  it  consists  of  that  amount  of  current  assets 
which  IS  not  furnished  by  trade  and  other  short-time 
creditors  and  by  temporary  bank  loans. 

The  amount  of  fixed  capital  required  by  any  corpora- 
tion depends,  of  course,  on  the  nature  of  its  operations, 
industrial  and  mining  corporations  must  have  machin- 
ery; railroad  companies  must  have  track  and  rolling 
stock;  trading  companies  must  have  office  furniture  be- 
fore they  can  start  business.  The  necessary  total  of 
fixed  capital  is  not  always  so  great  as  it  appears  to  an 
outsider,  for  the  reason  that  in  most  enterprises  land, 
buildings  and  even  machinery  can  be  rented  to  better 
advantage  than  they  can  be  bought.  Accountants  rec- 
ognize this  fact  and  are  in  the  habit,  in  estimating  the 
true  cost  of  production  in  a  manufacturing  establish- 
ment, of  charging  an  estimated  rent  for  the  land  and 
buildings  even  though  they  be  owned  in  fee  by  the 
corporation.  It  is  well  for  corporation  managers  to 
consider  this  possibility,  especially  in  starting  a  new 
enterprise,  and  where  possible  avoid  the  investment  of 


INVESTMENT  OF  CAPITAL  FUNDS 


341 


lar^'c  i»iims  in  fixed  assets  until  after  the  success  of  the 
enterprise  is  assured. 

One  of  the  characteristics  of  fixed  capital  Is  that,  al- 
thoii^^h  it  may  be  essential  and  valuable  to  the  corpora- 
tion wliieh  owns  it,  it  is  likely  to  have  very  little  value 
if  put  on  the  market  for  sale.  Its  value  remains,  in 
other  words,  only  so  long  as  the  concern  is  "going." 
Therefore,  the  smaller  the  proportion  of  a  corporation's 
capital  invested  in  fixed  assets,  the  better  off  it  is  in  case 
of  failure  or  bankruptcy. 

180.  Forms  of  working  capital. — Working  capital 
may  take  any  or  all  of  four  forms: 

(1)  Cash,  either  on  hand  or  in  banks. 

(2)  Bills  and  accounts  receivable. 

(3)  Raw  materials  and  finished  products  in  stock. 

(4)  Securities  of  other  corporations  held,  not  for 
control,  but  for  temporary  investment. 

As  an  illustration  take  the  following  table,  which 
shows  the  current  assets  and  current  liabilities  of  the 
United  States  Rubber  Company  for  two  recent  fiscal 
years,  as  shown  on  the  published  balance  sheets,  and 
the  working  capital,  or  excess  current,  assets  over  cur- 
rent liabilities: 


CURRENT    ASSETS. 

Inventories $18,404,726  $18,088,169 

(Hsh 2,061,401  2,728,880 

Bills  receivable 8,681,126  9944250 

Accounts  receivable 8,687,681  8,494,284 

Totals $82,884,884  $25,746,088 


842 


CORPORATION  FLNANCE 


tl 


CUBRENT    LIABILITIES. 

Loans  and  notes  payable $  6,821,077  $  2,440,077 

Accounts  payable 737,384  362,634 

Due  General  Rubber  Co 7,269,441  7,164,111 

Reserve  for  discount 872,989  874,735 

Totals $1 5,700,891  $10,841,657 

Working  capital $17,133,993         $14,903,476 

181.  How  much  working  capital  shall  he  carried?— 
The  amount  of  actual  cash  needed  by  a  corporation 
varies  with  the  size  of  its  pay-roll  and  other  current 
demands  for  cash,  with  the  amount  and  character  of  its 
accounts  payable  considered  in  connection  with  its  ac- 
counts receivable,  with  the  discounts  that  it  may  obtain 
on  purchases  by  making  cash  payments,  and  with  its 
facilities  for  securing  temporary  loans.  The  force  of 
these  considerations  must  be  estimated  by  the  corpora- 
tion managers.  Obviously  there  is  a  waste  in  carrying 
unnecessarily  large  bank  balances;  if  any  interest  is 
received  on  sucli  balances,  it  will  not  usually  run  higher 
than  3  per  cent.  On  the  other  hand,  every  corporation 
naturally  desires  to  stan,'  -veil  with  banks  and  will  carry 
large  enough  I)alances  to  make  its  deposits  worth  having. 
Otherwise,  the  corporation  in  times  of  difficulty  may 
turn  to  banks  in  vain  for  temporary  assistance. 

The  amount  of  accounts  receivable  cannot  be  dete^ 
mined  by  the  financial  management  of  a  corporation, 
but  depends  on  the  volume  of  sales,  on  the  custom  of  the 
trade  as  regards  payment  and  on  the  efficiency  of  the 
credit  department  in  granting  credits  and  in  making 
collections. 

The  amoimt  of  finished  products  and  raw  materials 
on  hand  is  directly  determined,  of  course,  by  the  operat- 
ing department  of  each  company.  Nevertheless,  the 
executive  heads  of  the  company  should  and  usually  do 


INVESTMENT  OF  CAPITAL  FUNDS 


34S 


txerc'ise  some  discretion  in  this  regard,  particularly  with 
a  vitw  to  reducing  the  amount  of  working  capital  thus 
invested  to  a  minimum.  A  great  many  manufacturing 
corporations,  on  account  of  improper  purchasing  and 
accounting  methods,  are  wasteful  in  this  regard.  Care- 
ful perpetual  inventories  of  goods  in  stock  will  often 
make  it  possible  to  buy  and  sell  more  closely  without 
interfering  in  the  least  with  the  operating  efficiency  of 
the  business.  Although  this  is  a  topic  which  belongs 
rather  to  organization  and  accounting  than  to  finance, 
its  importance  to  a  corporation's  financial  management 
should  not  be  overlooked. 

182.  The  practice  of  large  corporations. — The  fol- 
lowing compilation  made  by  the  Wall  Street  Journal 
is  of  particular  interest  in  that  it  shows  the  practice 
with  regard  to  working  capital  of  the  largest  and  best- 
managed  corporations. 

A  study  of  reports  of  the  leading  industrial  companies  shows 
that  the  United  States  Steel  Corporation  takes  the  lead  in  work- 
ing capital,  with  the  Standard  Oil  Co.  second,  the  International 
Harvester  Co.  third  and  the  General  Electric  Co.  fourth. 

Including  sinking  and  reserve  fund  assets  invested  in  securi- 
ties, amounting  to  $32,442,400,  the  working  capital  of  the 
U.  S.  Steel  Corporation  is  $261,789,886. 

The  International  Harvester  Co.,  aside  from  the  Standard 
Oil  Co.,  probably  has  a  larger  working  capital  to  gross  business 
than  any  other  corporation  of  consequence.  Its  working  capi- 
tal as  of  December  81,  1907,  aggregated  $77,087,811,  while  its 
gross  business  amounted  to  only  $78,206,890. 

The  General  Electric  Co.  also  shows  up  well  from  the  stand- 
point of  working  capital,  reporting  $61,235,724  on  January 
31  last,  compared  with  its  gross  businesti  cf  $70,977,168. 

The  following  table  gives  the  working  capital  of  several 
of  the  prominent  industrial  companies,  togetlter  with  gross 
business  and  capitalization: 


■t 


p 


344  CORPORATION  FINANCE 

Company.  ^''°"  ^Vorking  Capital 

Bminess.  Canial.  stock 

United  States 

Steel  Corp'n.. $767,014,767  •$261,        885       $868,588600 
Standnrd     Oil  ' 

Company    250,000,000         100,027,150 

Inter.  Harvester 

Company....      78,206,890         77,087,811         120,000,000 
General  Electric 

Company....      70,977,168         61,235,724  65,167,400 

West.  Elec.  Mfg. 

Company....      83,026,240         19,061,807  24,969,000 

Lackawanna  St'l 

Company....      38,011,410         13,881,340  84.721400 

Republic  I.  &  St'l 

Company....     81,229,428  6,720,000  47,607,900 

Bethlehem    Steel 

Company....      15,000,000  7,434,573  29,770,000 

Am.  Steel  Found. 

Company....      19,463,521  4,834,843  17,184,000 

Midvale   Steel 

Company i  ,804,929  750,000 

Alii  s-Chalmers 

Company 12,522,074  86,790,000 

Cambria  Steel 

Company 1 4,597,865  45,000,000 

"To**' $780,970,851    $1,889,670,450 

The  above  figures  show  that  the  twelve  companies  in  question 
are  well  fortified  with  working  capital.  The  aggregate  working 
capital  stands  at  $780,970,851,  as  compared  with  total  stock 
capitalization  of  $1,889,570,450. 

The  figures  given  above  indicate  that  the  companies  in  ques- 
tion are  in  a  strong  position  to  weather  any  depression  that 
may  reasonably  be  exix-cted. 

•  Inrludes  sinking  and  reserve  fund  assetn  amounting  to  |3d,4«l,40L 


INVESTMENT  OF  CAPITAL  FUNDS 


S45 


To  invest  working  capital  to  any  considerable  amount 
in  the  securities  of  other  corporations  is  not  a  very  coni- 
inon  or  coiiunemlable  practice.  It  is  justifiable  only  in 
those  companies  that  have  great  fluctuations  in  demands 
cush  and  that  cannot  secure  fair  mterest  on  bank 


tor 


halances.  The  buying  and  selling  of  securities  is  no 
jjiirt  of  the  business  of  any  corporations  except  the  few 
which  are  distinctly  organized  for  that  purpose.  Prof- 
its that  are  derived  from  this  source  are  justly  regarded 
as  speculative  and  highly  uncertain. 

183.  Factors  that  affect  working  capital. — Consider- 
ing the  situation  as  a  whole  the  proportion  of  working 
to  fixed  capital  in  any  business  may  be  said  to  depend 
upon  five  fact'~rs,  as  follows: 

(1)  Volume  of  business. 

(2)  The  regularity  of  supply  of  whatever  raw  ma- 
terials are  used  and  the  savings  which  may  be  effected 
hy  huying  raw  materials  in  large  quantities.  If  it  is 
necessary  for  the  corporation  to  pick  up  large  batches 
of  raw  materials  at  irregular  periods  in  order  to  get  ad- 
\antageous  terms,  of  course  the  working  capital  must 
be  correspondingly  increased,  for  two  reasons :  first,  be- 
cause larger  amounts  of  raw  materials  must  be  carried 
in  stock  than  would  otherwise  be  necessary;  second,  be- 
cntiso  larger  bank  balances  must  be  maintained  in  order 
to  meet  these  irregular  demands. 

(3)  Regularity  of  the  demand  for  the  product  of  the 
corporation.  The  same  considerations  apply  here  as 
were  named  in  connection  with  the  preceding  factor. 

(4)  Customs  of  payment  in  the  business.  Some 
manufacturing  corporations  normally  buy  on  90  days* 
time  and  sell  on  80  days*  time.  This  arrangement  makes 
it  possible  to  meet  the  accounts  payable  out  of  accounts 


846 


CORI'OKATION  FINANCE 


receivable  and  lessens  the  necessary  amount  of  working 

(5)  The  length  of  time  required  to  turn  out  the 
finished  product.  It  takes  three  or  four  years  normally 
to  bmld  a  b.g  steam  vessel.  During  that  period  the 
ship-buildmg  corporation  will  necessarily  pay  out  larm 
sums  for  lumber  and  materials  and  a  big  working  capi- 
tal, therefore,  will  be  necessary.  The  same  remark  ap- 
plies to  all  concerns  in  which  the  period  of  manufacture 
IS  lengthy. 

There  is  one  great  industry  of  the  United  Sutes 
.which  can  usually  get  along  with  a  very  small  proportion 
of  M'orking  capital,  namely,  railroad  operation.  The 
prime  reason  is  that  the  railroads  are  manufacturing  a 
commodity,  that  is,  transportation,  which  is  continually 
.m  ilemand  and  which  is  paid  for  ordinarily  as  soon  as  it 
IS  produced.  There  are  no  outlays  to  speak  of  for  cur- 
rent raw  materials;  the  only  raw  materials  that  railroads 
use  are  for  fixed  assets  and  may  be  regarded  as  part  of 
the  cost  of  securing  fixed  capital. 

184.  The  icorking  capital  of  the  Pennsylvania  Rail- 
road.~KvL'n  among  railroads  there  may  be  exceptional 
circumstances    which    make   necessary    large    working 
capitals.     The  I'enusylvania  Railroad,  for  example,  in 
the  early  part  of  1909  was  completing  its  immense  ter- 
mmal  improvements  in  and  near  Xew  York  City.     In  a 
sense  it  was  engaged  in  the  contracting  business  on  a 
great  scale,  for  it  was  building  tracks,  tunnels  and  sta- 
tions.    Therefore,  it  needed  ten.porarily  as  much  work- 
mg  capital  as  a  manufacturing  corporation  should  have 
Making  a  strict  classification  of  current  assets  and 
liabilities,  the  Pennsylvania  Railrc«d's  cash  posit*  ,n  at 
the  end  of  1908  compared  with   its  position   twelve 
months  liefore  as  follows : 


INVESTMENT  OF  CAPITAL  FUNDS  847 

CURRENT  ASSETS. 

1908  190r                        Char,ge$ 

( .i>li *5(i,0:J5,H9S  $37;J85,673  Inc.  f  1^640^34 

Hills  &  ,i< lis.  ricv U^94.0H0  1»,0(J9,840  Dec.      3,775,760 

Cash  asMls   $70;J19,97H  955,455^13  Inc.  914,864.465 

CUUKENT  LIABILITIES. 

I'iiyn.lU  \  v <>iuh $14,:?27,:W;9  ^0,326,1641  Dec. 9  5,998.795 

Int.  .inriinl,  etc 3,i31,;J48  3,875,982  Inc.         355,366 

.\|i^c<•llllll.lllls 4,211,496  3,9«6,996  Inc.         244,500 

Curniit  liabilities    921,670,1 13  937,0(,«,142  Dec.  9  5,399,029 

Excels  lur.  assets 48,649,865  28,386,371  Inc.     20,263,494 

This  makes  the  company's  net  free  capital,  subject  to 
the  company's  need  of  money  to  carry  on  its  everyday 
business  of  transportation,  more  than  $48,000,000  and 
SJO.OOO.OOO  in  excess  of  what  it  had  been  the  year  before. 
Tlu  other  assets,  not  to  be  classed  as  quick  items  but 
more  or  less  subject  to  liquidation  in  time,  and  deferred 
and  contingent  liabilities,  compare  as  follows: 

DEFERRED   AND  CONTINGENT  ASSETS. 

190fi  1907  Chamgtt 

Our   otl    N.    \     W.    &    C.    & 

< '  -t"'lv> 915,492,68,';  915,492,685                       

I. ..in.  tor  ( cms..  &r 12.t03,KS4  18,412,493  Dec.  9  6,OO8,05» 

Diif  from  ('iintri>llrH  cnni- 

l''"'<> 3,159,784  462,218  Inc.       2.697,5«« 

Mit.  rills  on  hand 10,«9,483  15,929,925  IVc.      5,480,U2 

.Sink,    fund    assets M.lt8,308  7,772,627  Inc.         375,581 

'l"'»t'l 9*9.653,994  958,069,948  Dec.  9  8,4I5,9M 

DEFERRED  AND  CONTINGENT  LIABILITIES. 

Cir  tnisN  rhfMl  out 9  2,043,fl03  $  1,4244171  In<r.  %     «18,932 

Tixis  (hjpl  i.ut    2,731,1(19  3,023,197  Dec.         292,088 

!)tir  I'.-nna.  Co 2,290,897  Dec.      2,290,897 

I  Mr.  .  xf>.  fund 2.500,0O()  De« .      2,500/X)0 

Sinking'  furi.l  llnb 10339,0.57  9»\i<»M  Inc.        523,101 

'  "•  'I   915.1 13.969  919.054,921  Dec.  9  34»40,952 

•  *  -    .lif.  4  con.  «wt».93*.540,0«5  939.015,027  Dec. f  4,474.002 


848 


CORPORATION  FINANCE 


til 


185.  General  conclusions  as  to  working  capital- 
Many  other  industries,  particularly  those  inanufactur 
ing  staple  articles  of  trade,  require  a  comparatively 
small  proportion  of  working  capital.  On  the  other 
hand,  there  are  Imes  of  business,  such,  for  instance  as 
publishing,  in  which  only  a  little  fixed  capital  (offiee 
furniture,  plates,  etc.,  chiefly)  is  needed.  This  is  true 
more  or  less  of  all  trading  corporations. 

As  was  intimated  at  the  beginning  of  this  chapter,  the 
principles  herein  laid  down  are  of  a  very  broad  and 
general  nature  and  can  be  successfully  applied  only  by 
keen   intelligence.     Perhaps   the  chief  practical  con- 
clusion is  that  the  most  careful  thought  must  be  given 
to  securing  a  proper  proportion  of  working  capital.    No 
matter  how  valuable  the  fixed  assets  of  a  corporation 
may  be,  if  it  does  not  have  all  the  funds  necessary  to 
transact  current  business  and  to  meet  current  obliga- 
tions, it  will  inevitably  prove  a  failure.     Right  here  is 
where  most  of  the  mistakes  and  failures  of  the  early 
stages    of   corporate    management    occur.     :Managers 
trust  that  the  current  sales  will  take  care  of  current  ex- 
penses; when  the  inevitable  hitch  occurs  they  have  no 
other  resources  to  use  and  the  corporation  suddenly 
plunges  into  the  quicksands  of  financial  trouble  and  dis- 
credit.    This  problem  of  providing  sufficient  working 
capital  will  crop  out  again  when  we  come  to  consider 
the  causes  of  corporate  insolvency. 


CHAPTER  XXII 


DISPOSITION  OF  GROSS  EARNINGS 

186.  Determination  of  income. — The  ordinary  fomi 
of  income  statement  of  a  corporation  is  somewhat  as 

follows : 

(a)  Gross  earnings  from  operation  or  manufacture. 

(b)  Deduct  operating  or  manufacturing  ex- 

penses. 

(c)  Net  earnings  from  operatioi:  or  manufacture. 

(d)  Add  income  from  other  sources. 

(e)  Total  income. 

(f)  Deduct  taxes. 

(g)  Balance  applicable  to  fixed  charges. 
(h)  Deduct  interest. 

(i)  Deduct  rentals. 

( j )  Deduct  sinking  fund  and  other  charges. 

(k)  Balance  applicable  to  dividends  and  surplus. 
(1)  Deduct  dividends, 

(m)  Surplus  from  the  year's  operations. 

It  goes  without  saying  that  each  corporation  has  its 
own  method  of  stating  ac?:ounts  and  that  there  are 
many  variations  from  this  standard  form.  The  essen- 
tial items,  however,  are  those  stated  above.  It  would 
be  weH  for  the  reader  to  study  with  some  care  the  income 
accounts  of  large  corporations  which  are  made  public 
from  time  to  time  and  which  are  printed  in  the  financial 
cojnnms  of  all  inetroiH)litan  newspapers.  If  any  of  the 
ifims  given  above  are  not  altogether  clear,  the  reader 


35U 


couporat:o\  finance 


should  turn  to  the  volume  on  Accounting  Practic, 

The  relations  between  accounting  and  finance  are  «, 
close  that  a  fair  understanding  oMhe  has^cpr  ne  ,^ 
o    aceonnting  is  necessary  in  order  to  deal  intellS 
v.th  the  prob  ems  of  financial  management.     In  wh" 
is  saul  below  m  reference  to  each  of  the  items  in   h 
mcH^nje  account  it  will  be  assun.ed  that  the  reader 
fam,l.ar  w,th  accounting  terms  and  with  the  element 
of  accounting  i^ractice. 

187    Honestif  in  stating  gross  carnings.-Perhm 
he  only  comment  needful  on  the  first  item  "gross  earS! 
ings    .s  that  ,t  should  be  honestly  stated.    This  remark 
IS  tnte  enough,  and  yet  not  uncalled  for.    A  great  nZ 
corporation  managers  are  in  the  habit  of  including  in 
the.r  gross  earnings  sales  that  have  been  made  to  parties 
of  doubtful  credit  which  are  represented  merely  l,y  a  ! 
couns  receivable  that  are  probably  bad.     In  L  case 
f  holding  companies  it  is  not  so  uncommon  as  it  should 
be  to  include  in  the  gross  earnings  sales  made  from  one 
company  to  another  in  the  combination.    Of  course  this 
IS  simply  a  juggling  with  figures.    A  still  more  flag- 
rant   instance    of   dishonesty    was    disclosed    by   Mr. 
Mephen  L.ttle,  an  accountant  of  wide  reputation,  who 
n  1804  was  called  upon  to  investigate  the  condition 
of  the  insolvent  Atehison,  Topeka  and  Sante  Fe  Rail- 
road Company.    Mr.  Little  found  that  the  railroad  had 
paid  out  millions  <,f  dollars  in  rebates  to  shippers  which 
had  nc»t   been  deducte<l   from   its   statement  of  grr«s 
earnings,  '^ 

188.  irhat  arc  opcmtim,  r.r/>rw*f*?  Operating  ex- 
pense's are  also  often  grossly  misstated,  although  in  this 
instance  the  fault  is  apt  to  be  due.  not  so  much  to  the 


DISPOSITION  OF  GROSS  KAUMNXiS 


351 


(lisliontsty  of  the  corporation  managers,  as  to  their 
i^rnorunce  of  correct  accounting  principles.  The  oper- 
ating' expenses  ought  always  to  include  not  only  the 
actual  expenditures  for  raw  materials,  lahor  and  current 
repairs,  hut  also  a  liberal  allowance  fcr  anticipated  re- 
pairs and  renewals  and  for  depreciation. 

Repairs  in  the  early  years  of  a  corporation's  activities 
are  seldom  as  great  a  l)urden  as  in  later  years.  Ac- 
0)iintants  figure  that  most  manufacturing  machines  will 
show  a  rising  percentage  of  necessary  repairs  each  year 
for  the  first  five  to  ten  years  of  their  existence  and 
after  that  a  fairly  steady  ratio  will  be  maintained.  Now 
it  is  evident  that  unless  some  allowance  is  made  during 
the  first  few  years  for  the  rise  in  this  item  during  the  fol- 
lowing years,  a  misleading  statement  of  operating  ex- 
penses will  be  presented. 

Corporations  differ  greatly  in  their  handling  of 
charges  for  renewals  of  machinery  and  equipment. 
Many  of  them  figure  that  the  new  machines  they  buy 
are  additions  to  their  capital  and  therefore  should  not 
he  charged  against  the  income  account  at  all.  If  the 
new  machine,  however,  replaces  to  any  extent  an  old 
maeliine.  this  reasoning  i^^  obviously  incorrect.  Only 
the  difference  between  the  value  of  the  old  and  the  value 
of  the  new  machine  could  j)roperly  be  charged  to  capital 
aeeontjt.  Conservative  corporations  in  this  country, 
railroads  particularly,  are  in  the  habit  of  charging  the 
whole  cost  of  the  new  cijuipment,  as  a  rule,  as  a  part 
of  operating  expenses.  The  Knglish  railroad  practice, 
"H  the  other  hand,  is  t(»  charge  the  whole  expense  to 
lapitnl  and  to  raise  new  capital  fimds  to  meet  it.  We 
nIiiiII  have  <K"casion  to  consider  this  point  further  in  con- 
iKctinii  with  "!)etterment  expenses." 
1Ht>.  Xccetnty  for  depreciation  reserves. — Tlie  sub- 


352 


COUI'OUATION  FINANCE 


« 


a 


lilt 

m 


>  • 

h 


ject  of  depreciation  is  too  large  and  important  to  re- 
ceive full  consideration  in  this  place;  a  more  extended 
treatment  will  be  found  in  the  volumes  on  accounting. 
As  the  desirability  of  allowing  properly  for  deprecia- 
tion ought  to  be  indelibly  impressed  on  the  mind  of 
every  person  interested  in  corporation  management, 
however,  some  brief  remarks  on  the  subject,  even  at  the 
risk  of  reiteration,  are  worth  making  here. 

There  are  three  general  causes  of  depreciation,  as 
follows : 

(a)  Failure  to  keep  property  in  first-class  working 
condition. 

(b)  The  gradual  breaking  down  of  property  in  spite 
of  all  that  may  be  done  to  keep  it  in  good  condition. 

(c)  ^lost  important  of  all,  obsolescence  or  the  im- 
pairment of  value  because  of  new  inventions  and  pro- 
cesses. 

It  is  difficult  for  anyone  not  directly  familiar  with 
modern  manufacturing  enterprises  to  conceive  of  the 
rapidity  with  which  changes  in  mechanical  methods  fol- 
low each  other.    Each  important  change  is  apt  to  make 
necessary  a  general  revision  of  all  the  machinery  and 
processes  of  manufacture.     In  the  intense  competition 
between  industries,  no  concern  that  allows  itself  to  fall 
behind  in  the  race  to  install  the  latest  and  most  eco- 
nonncal  devices  will  long  be  able  to  survive.    American 
manufacturers  have  long  been   famous  for  the  vifpw 
and  fearlessness  with  which  they  adopt  new  machinery 
and  processes,  even  though  the  ohanifc  may  make  almost 
worthless  the  expensive  e<|ui|)ment  that  liad  previously 
been  installed.    The  Carnegie  Steel  Company,  it  is  said, 
time  after  time,  has  relentlessly  sent  to  the  scrap  heap 
costly  machi-'.es  and  even  whole  plants  that  were  found 
to  be  inferior  to  new  inventions. 


DISPOSITION  OF  GROSS  EARNINGS  353 

This  polity  certainly  pays  in  the  long  run,  as  the 
striking  success  of  the  Carnegie  Steel  Company  shows. 
Where  products  are  being  turned  out  in  great  quantities, 
a  very  shght  saving  in  the  cost  of  producing  each  unit 
may  i>r()ve  to  be  the  margin  between  bankruptcy  and 
prosperity.    Yet,  though  the  policy  is  to  be  praised  and 
followed,  it  nuist  not  be  forgotten  that  it  involves  large 
lossts  lor  the  time  being  whenever  old  machines  are 
superseded  by  new.    These  losses  ought  to  be  foreseen 
and  i)rovidc<l  against  when  the  first  step  of  an  ente/- 
pris(  nre  taken.     The  only  possible  means  of  so  do- 
in;;  is  to  charge  as  part  of  the  operating  expenses  every 
year  a  liberal  sum  of  depreciation— a  sum  that  will 
take  care,  not  merely  of  decay  due  to  old  age  and  lack 
of  re])air,  but  of  obsolescence  as  well. 

Anything  like  a  scientific  treatment  of  depreciation 
has  iitilortunately  been  conspicuously  absent  from  the 
acenniits  of  most  American  corporations.     Manufac- 
turers have  been  too  willing  to  make  rough  guesses 
Mhere  fairly  oract  scientific  deductions  might  have  been 
drawn.     Electric  and  steam  railroads  have  uniformly 
declined  to  make  any  allowance  whatever  for  deprecia- 
tion on  the  ground  that  the  value  of  their  franchises  is 
steadily  rising  and  that  this  is  sufficient  to  offset  what- 
ever depreciation  of  their  property  is  going  on.    There 
IS  ;i  certain  amount  of  truth,  to  be  sure,  in  this  assertion; 
}'i  it  reveals  a  woefully  careless  habit  of  thought. 
Siieli   slap-dash   methods    fortunately   are   now   being 
nadicatcd,  so  far  as  interstate  steam  and  electric  lines 
iin  eoiuerned,  through  the  control  over  their  accounts 
now  exereised  by  the  Interstate  Commerce  Commission. 
Itoeent  rulings  of  the  Commission  have  very  properly 
mide  it  obligatory  on  railroads  to  form  as  accMirate 
estimates  as  they  can  of  annual  depreciation  of  their 
f"— VT— 2.*? 


854 


CORPORATION  FINANCE 


If  • 


li 


property  and  to  set  aside  every  year  as  part  of  operating 
expenses  an  adequate  depreciation  charge. 

To  avoid  any  possible  misunderstanding  by  those 
who  may  not  be  familiar  with  accounts,  it  may  be  well 
to  state  at  this  point  that  depreciation  reserves,  so  called, 
are  not  sums  set  apart  and  invested  outside  of  the  prop- 
erty, but  are  merely  the  total  charges  against  gross 
earnings  over  a  series  of  years  on  account  of  deprecia- 
tion.  The  depreciation  reserves  are  not  separable  from 
other  capital  funds  invested  in  the  business  except  as 
a  matter  of  accounting. 

190.  Income  from  other  sources  and  deductions.^ 
We  have  now  reached  in  our  income  statement  the  item 
"net    earnings    derived    from    operation."     To    these 
earnings  should  be  added  "income  from  other  sources." 
In  order  to  nmke  the  income  account  a  clear  and  ac- 
curate statement  of  results  of  the  year's  operations, 
it   is  very   important   that   this   "income   from  other 
sources"  should  be  stated  separately  and  not  confused 
with  "net  earnings  from  operation";  otherwise  the  cor- 
poration managers  will  be  claiming  credit  for  returns 
that  are  quite  distinct  from  the  company's  oAvn  opera- 
tion.    Income  from  other  sources  includes  dividends 
on  the  stocks  of  subsidiary  and  other  companies,  inter- 
est on  the  bonds  of  such  companies,  interest  on  bank 
deposits,  rentals  of  property  owned  by  the  corpora- 
tion and  not  used  in  its  own  operations,  and  other 
items  of  that   nature.     Sucli   returns   are   frequently 
temporary  or  irregular,  in  wliich  case,  in  order  to  make 
the  situation  clear,  they  ought  to  be  specifically  named 
in  the  income  statement. 

We  now  deduct  taxes  which,  it  will  be  noted  in  our 
model  income  statement,  should  nr)t  be  included  under 
fixed  charges.     There  is  some  difference  of  opinion  on 


DISPOSITION  OF  GROSS  EARNINGS 


855 


tliis  point.  It  is  not  a  matter  of  sufficient  importance. 
howtvtr.  to  be  worth  ar^^uing  over.  The  view  here 
taktii  is  that  taxes  are  variable  in  amount,  and  are  not, 
thtrctore,  on  the  same  basis  as  the  regularly  recurring 

fixed  diarges. 

As  to  the  nature  of  interest  and  rentals,  little  need 
here  hv  suid.  Sinking  funds  have  been  sufficiently 
treated  for  our  purpose  in  another  place. 

The  deduction  of  fixed  charges  leaves  as  a  balance 
the  income  applicable  to  dividends  and  surplus.     Pre- 
ferred dividends,  as  have  previously  been  explained,  are 
classified  as  cumulative  and  non-cumulative.     Cumula- 
tive (hvidends,  to  the  corporation  managers,  are  often 
extremely  disagreeable  things.     They  are  not  so  bad  as 
interest  charges,  for  they  may  be  deferred  as  often  as 
necessary.     On  the  other  hand,  the  fact  that  they  are 
ciimiihifive  makes  them  pile  up  at  an  alarming  rate, 
and  in  the  course  of  a  very  few  years,  if  they  are  not 
paid,  they  hecomt  a  charge  ahead  of  the  common  stock 
that  makes  common  stock  dividends  seem  an  unattain- 
able vision.     For  the  best  interests  of  common  stock- 
hohlers,  therefore,  it  is  usually  very  desirable  to  pay 
cuninhitive  preferred  dividends  regularly.     If  a  shrink- 
tm-  in  profits  makes  a  temporary  lapse  necessary,  the 
lost  ground  should  be  regained  at  the  first  opportunity. 
101.  Ilntv  much  shall  he  paid  out  in  dividends,— The 
next  (|ucstion  to  consider  in  disposing  of  the  earnings 
"f  a  corporation  is.  How  much  shall  be  paid  out  in  non- 
niniiilative  and  in  common  dividends.     Mr.  Thomas 
F.  AVoodlock  has  well  said  that  the  payment  of  divi- 
dends IS  the  only  absolutely  non-productive  expenditure 
that  an  honest  corporation  makes.     This  may  sound  like 
t  nu  aningless  paradox,  but  it  is  literally  true.     So  far  as 
the  corporation  itself  is  concerned,  whatever  is  paid  out 


MICROCOPY   RESOLUTION   TEST   CHART 

(ANSI  and  ISO  TEST  CHART  No    2l 


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35G 


CORPORATION  FINANCE 


I  • 


in  dividends  is  a  total  loss.  On  the  other  hand,  it  is 
also  true  that  the  only  reason  for  the  corporation's  ex- 
istence is  that  it  may  pay  dividends  to  the  stockholders 
There  is  a  conflict  of  interest  here  evidently  and  often 
a  strong  conflict  of  opinion  between  the  managers  of 
a  corporation  and  the  stockholders  as  to  whether 
dividends  should  be  paid  or  not.  In  the  next  chapter 
some  striking  examples  will  be  cited. 

Assuming  that  a  corporation  has  a  balance  for  the 
year  applicable  to  dividends  and  surplus,  and  that  all 
persons  concerned  are  agreed  that  some  dividends  should 
be  paid,  the  question  takes  the  form.  How  large  an 
amount  shall  be  thus  distributed  to  stockholders?  The 
first  and  most  natural  answer  to  this  question  is  that  all 
the  profits  of  each  year  belong  to  the  stockholders  and 
should  be  paid  out  in  dividends;  and  this  answer  is 
deemed  entirely  satisfactory  by  many  intelligent  people. 
The  English  corporations  almost  invariably  follow  this 
practice,  and  some  important  American  corporations 
as  well.  The  New  York  Central  Railroad  Conipany, 
for  instance,  has  for  many  years  paid  out  in  dividends 
each  year  almost  all  the  net  earnings  of  the  year. 

There  are  two  distinct  disadvantages  in  this  practice: 
First,  it  does  not  permit  the  corporation  to  create  a 
surplus  of  any  considerable  size;  second,  it  makes  the 
dividend  rate  irregular.  The  first  disadvantage  will  be 
more  fullv  discussed  in  Chapter  XXIII.  The  second 
disadvantage  is  of  great  importance  and  calls  for  some 
explanation. 

192.  Variahilitif  of  profits.— In  all  lines  of  business 
the  profits  necessarily  vary  from  year  to  year.  This  is 
tnie  because  all  tlie  factors  which  enter  into  and  d^ 
termine  profits  are  variable.    These  facts  are: 


DISPOSITION  OF  GROSS  EARNINGS 


357 


(a)  Volume  of  sales. 

(b)  Prices  obtained. 

(c)  Prices  of  raw  materials. 

(d)  Wa.as. 

In  no  line  of  business  is  the  volume  of  sales  the  same 
from  year  to  year  and  in  no  line  even  where  the  general 
trend  is  upward  can  the  volume  be  expected  to  increase 
steadily  and  regularly.  Some  fair  degree  of  regularity, 
to  be  sure,  can  be  attained  in  the  cases  of  large  public 
service  corporations,  such  as  waterworks,  street  railways 
and  steam  railroads,  that  deal  with  great  masses  of 
people.  Even  here  there  are  sometimes  surprising  fluc- 
tuations. In  most  lines  of  industry,  prices  are  very 
unstable  and  show  big  variations  from  year  to  year.  In 
fjeneral  it  may  be  said  that  those  industries  have  the 
most  regular  prices  and  volume  of  sales  which  are  con- 
cerned with  the  necessities  of  life;  and  the  farther  you 
^t't  away  from  those  necessities,  the  more  violent  are 
the  fluctuations  in  those  two  items. 

To  make  these  statements  more  definite  let  us  examine 
the  records  of  some  of  the  leading  industrial,  street  rail- 
road and  steam  railroad  companies  during  the  year  of 
depression,  1908.  The  following  gives  the  percentage 
of  production  of  the  leading  industrial  companies,  com- 
pared with  normal: 

United  States  Steel  Corporation 60 

Republic  Iron  and  Steel 90 

I.iikcns  Iron  &  Steel 60 

Corn  Products  Refining 75 

Stiindnrd  Oil 95 

General  Electric 60 

Wcstinghouse 60 

PcnnNvlvania  Steel 60 

Maryland  Steel 60 


358 


CORrORATION  FINANCE 


Jones  &  Laughlin 55 

Amalgamated  Copper 100 

National   Lead 95 

American  Smelting  &  Refining 80 

Sloss-Sheffield  Steel  &  Iron 80 

International  Paper 70 

United  States  Rubber 75 

Allis-Chalmers 65 

American  Can 75 

American  Car  &  Foundry 35 

Pressed  Steel  Car 20 

Railway  Steel  Spring 75 

American  Locomotive 4:0 

Bethlehem  Steel  Corporation 50 

International  Harvester 100 

United  States  Realty  &  Improvement 100 

Orders  for  new  railway  equipment  in  1908  were  less 
than  40  per  cent  of  those  received  during  1907  and 
hardly  20  per  cent  of  orders  booked  in  the  big  rush  of 
business  in  1905.  The  course  of  new  business  during 
the  preceding  four  years  may  be  gathered  from  the  fol- 
lowing comparison : 

Year  Loco.  Orders      Fgt.  Car  Orders 

1908  1,182  62,700 

1907  8,282  161,700 

1906  5,642  310,816 

1905  6,265  841,316 

In  striking  contrast  is  the  record  of  the  following 
railroad  and  street  railway  companies.  Notice  partic- 
ularly the  small  fluctuations  in  the  street  traffic  in  large 
cities.  The  decrease  in  street  railway  gross  earnings 
was  less  than  1  per  cent  and  in  steam  railroad  gross 
earnings  about  19  per  cent. 


DISPOSITION  OF  GROSS  EARNINGS 


359 


ELECTRIC    STREET    RAILWAYS. 

Coniiiaiiy  and  Period                          1908  1907  Decrease. 

I5.)ston,  May-July   •$  3,596,000  $  3,623,000  $  37,000 

Miss.  Elec,  Apr.-Junc 1,995,813  1,924333  '71,509 

lliicago  Rys.,  Mch.-May 2,6i5,533  2,571,324  •51,209 

Twin   City,  Apr.-Junc 1,174,389  1,492,671  18,282 

liiiteil  St.  Louis,  Mch.-May 3,645364  2,735,406  90,042 

Detroit  United,  Mch.-May 1,675,012  1,675,743  701 

Total   $14,012,170  $14,025,477  $13307 

*  Increase. 

STEAM    RAILROADS. 

Company  and  Period  1908  1907  Decreaits 

Lake  Shore,  April-June $  9,182,851  $11,160,400  $  1,977,549 

New  Haven,  April-June 10,913,741  12,670,010  1,756,269 

I'tniisylvnnia,   Jan.-Mch 31,375,489  37,203,589  5,828,100 

Louis.' &  Nashville.,  Feb.-Apr..  10,073,863  12,012,701  1,938,839 

Missouri  Pac,  Feb.-Apr 9,467,500  11,927,834  2,460324 

Boston  &  Maine,  Apr.-June...  8,836,556  10,499303  1,662,746 

Total $79,849,999  $95,473,826  $15,623327 

The  explanation  of  the  different  manner  in  which  the 
street  railways  and  steam  railroads  have  fared  is  largely 
to  be  found  in  the  different  character  of  their  traffic. 
Street  railway  gross  is  95  per  cent  derived  from  pas- 
senger receipts,  while  from  65  to  70  per  cent  of  railroad 
gross  is  realized  from  freight;  and  in  periods  of  uni- 
versal curtailment  freight  earnings  quickly  feel  the 
depression. 

Even  with  an  absolutely  invariable  volume  of  sales 
and  level  of  prices  any  industry  would  still  be  subject 
to  great  variations  in  profits  by  reason  of  changes  in 
raw  material  prices  and  in  wages.  This  statement  is 
obvious  enough  without  any  elaboration.  It  should  be 
remarked  that  the  amount  of  wages  paid  out  is  not  de- 
pendent altogether  on  the  nominal  rate  of  wages,  but 
also  to  a  great  extent  on  the  efficiency  of  labor.  When 
times  are  good  and  sales  in  all  lines  are  heavy,  it  becomes 


360 


CORPORATION  FINANCE 


necessary  to  employ  vvorkingmen  of  an  inferior  grade, 
who  in  bad  times  are  always  "out  of  a  job."  Taking 
on  such  men  means  a  great  reduction  in  the  average 
efficiency  of  labor  and  in  economy  of  production. 

193.  Regularity  of  dividends  desirable.— Wt  are 
safe  in  saying,  then,  that  great  fluctuations  in  profits 
are  inevitable  in  most  lines  of  business  and  cannot  be 
altogether  avoided,  even  by  the  large  public  service 
corporations  which  furnish  the  necessities  of  life.  It 
follows  that  if  all  the  earnings  each  year  are  paid  out 
in  dividends,  the  rate  of  dividends  will  fluctuate— in 
many  cases  fluctuate  violently.  The  reader  may  per- 
haps ask  at  this  point,  'Why  not  let  them  fluctuate  ?  Let 
the  stockholders  in  a  corporation  take  their  profits  as 
they  are  earned,  just  as  the  owner  of  an  individual  busi- 
ness or  partner  in  a  firm  would  do. 

The  answer  to  this  question  is  that  stock,  and  espe- 
cially the  stock  of  large  corporations,  is  widely  held  by 
people  of  all  classes  who  are  not  in  touch  with  business 
aiFairs  and  not  prepared  to  take  care  of  haphazard  re- 
turns that  drop  into  their  laps  from  time  to  time,  but 
who  desire  above  all  things  a  steady,  regular  and  de- 
pendable income.  Such  people  do  not  want  lean  years 
and  fat  years;  they  want  a  series  of  moderately  good 
years.  They  belong,  not  to  the  speculative,  but  to  the 
investment  class.  On  account  of  the  demand  that  such 
people  create  for  regular  dividend-paying  securities, 
the  market  prices  of  such  securities  are  far  higher  than 
they  would  otherwise  be.  For  example,  take  two 
stocks,  one  of  which  pays  over  a  series  of  five  years,  4 
per  cent,  7  per  cent,  6  per  cent,  3  per  cent  and  5  per 
cent,  averaging  H  per  cent  for  the  period,  and  compare 
it  with  another  stock  which  has  regularly  paid  5  per 
cent  each  year;  you  will  always  find  a  marked  differ- 


DISPOSITION  OF  GROSS  EARNINGS 


361 


dice  in  market  price  in  favor  of  the  second  stock.  The 
principal  reason  for  this  difference  is  that  so  many 
pct)ple  prefer  a  regular  dividend  payer. 

It  is  for  the  best  interests  of  all  a  corporation's  stock- 
holders to  pay  regularly  a  steady  rate  of  dividend, 
inasmuch  as  the  market  price  is  thereby  enhanced.  The 
corporation  manager,  then,  is  confronted  with  the  prob- 
lem of  reconciling  this  demand  with  the  irregularity  of 
the  corporate  profits.  The  only  safe  method  of  accom- 
plishing this  result  is  to  pay  out  in  dividends  no  more 
than  the  minimum  earnings  of  the  corporation  in  its 
worst  years.  Thus  the  dividends  may  always  be  kept 
at  a  fixed  rate  and  whatever  is  earned  above  the  dividend 
requirements  will  go  into  the  company's  surplus. 

194.  Prudence  in  paying  dividends. — This  may  seem 
an  unnecessarily  harsh  rule,  for  it  keeps  the  rate  of 
dividends  low  and  thereby  unnecessarily,  it  may  seem, 
cuts  down  the  stockholders'  income.  In  the  long  run, 
however,  it  works  no  injustice.  As  we  shall  see  in  suc- 
ceeding chapters,  whatever  surplus  is  saved  out  of  in- 
come, goes  to  increase  the  company's  earning  power  and 
eventually  its  regular  dividend  rate. 

Looking  back  over  the  ground  covered  in  this 
chapter,  we  see  that  great  care,  prudence  and  foresight 
on  the  part  of  a  corporation  directorate  in  the  distribu- 
tion of  gross  earnings  is  necessary  in  order  to  give  per- 
manence and  long-continued  success  to  the  corporation. 
The  board  of  directors  must  see  to  it  that  the  gross  earn- 
ing of  each  year  are  not  overstated  and  that  operating 
expenses  are  not  understated.  In  connection  with  the 
latter  item  they  must  take  care  that  sufficient  reserve  has 
hccn  set  aside  to  provide  for  accrued  repairs  and  for 
depreciation.  They  must,  of  course,  meet  all  the  fixed 
cliarges  of  the  corporation  out  of  income  under  penalty 


a(52 


CORPORATION  FINANCE 


I 


of  seeing  the  company  forced  into  bankruptcy.  They 
must  i)ay  cumulative  preferred  dividends  so  far  as 
practicable,  although  in  this  regard  some  discretion  is 
permitted  to  them.  Finally  they  nmst  resist  unwise 
pressure  from  stockholders  for  larger  dividends  than 
the  condition  of  the  company  in  the  long  run  will 
warrant.  If  they  do  not  resist  these  demands,  the  com- 
pany will  be  compelled  probably  sooner  or  later  to 
reduce  its  dividend  rate,  thus  removing  its  stocks  from 
the  class  of  desirable  investments  and  lowering  their 
market  prices.  The  ideal  corporation  director  will 
stand  like  Horatius  at  the  bridge,  defending  the  wealth 
and  profits  of  the  corporation  from  the  onslaughts  of 
hungry  stockholders  wlio  do  not  possess  either  foresight 
or  intimate  knowledge  of  the  business. 

A  corporation  which  has  such  a  directorate  is  peculi- 
arly fortunate  and,  whatever  its  line  of  business,  may 
reasonably  expect  to  attain  a  lasting  success.  A  cor- 
poration which  does  not  have  such  a  board  will  perhaps 
prosper  for  a  season  and  apparently  enrich  its  officers 
and  stockholders.  In  tlie  end,  however,  it  will  prove 
to  be  but  a  mushroom  growth.  All  the  while  its  vitality 
is  dwindling,  its  substance  is  being  eaten  out  and  sooner 
or  later,  to  the  surprise  of  unwary  investors,  it  suddenly 
crumbles  away. 


I 


CHAPTER  XXIII 


BETTIJIMENT  EXPENSES 

195.  Two  classes  of  betterments. — All  improvements 
and  all  expansions  of  property  may  be  grouped  under 
the  general  name  "betterments."  The  question  as  to 
whether  betterments  should  be  made  or  not  is  primarily 
something  for  the  operating  officials  of  the  company  to 
decide.  They  should  understand  thoroughly  the  condi- 
tion of  the  property,  the  cost  of  the  proposed  better- 
ments and  the  prospects  for  additional  business,  and 
from  the  study  of  these  factors  should  be  able  to  draw 
pretty  definite  conclusions  as  to  their  advisability. 

All  betterments  may  be  roughly  divided  into  two 
groups : 

(a)  Those  which  are  practically  certain  to  bring 
about  an  immediate  increase  in  revenue. 

(b)  Those  which  are  expected  to  prove  profitable  in 
the  long  run,  but  which  may  or  may  not  bring  immediate 
returns. 

As  an  example  of  the  first  class,  we  may  suppose  that 
a  manufacturing  company  is  about  to  put  in  a  new  and 
expensive  engine;  in  such  a  case  the  proper  officials 
should  be  able  to  calculate  in  advance  almost  exactly  the 
annual  saving  that  will  be  made  possible  by  this  partic- 
ular improvement. 

As  an  example  of  the  second  class,  we  may  suppose 
that  the  same  company  is  considering  the  advisability  of 
building  a  Young  Men's  Christian  Association  reading 
room  and  gymnasium  for  the  benefit  of  their  employes. 

868 


3G4 


CORPORATION  FlxNANCE 


•i 


> 
tl 


I 


Their  motives,  we  may  presume,  are  not  in  the  least 
phUanthropic;  they  expect  the  investment  to  yield  big 
returns  in  the  form  of  a  better  satisfied  and  more  intelli- 
gent force  of  workingmen.  The  extent  of  the  returns, 
however,  cannot  be  calculated  exactly  and  in  any  case 
will  not  be  immediate. 

The  dividing  line  between  the  two  classes  is  not  al- 
ways very  clear  and  there  may  often  be  more  difficulty 
than  in  the  two  examples  just  cited  in  assigning  a  pro- 
posed betterment  to  its  proper  class.  The  classification, 
however,  consciously  or  unconsciously,  is  almost  always 
made  by  intelligent  corporate  officials  and  directors. 

196.  Sources  of  funds  for  betterments.— Once  a 
betterment  expense  has  been  agreed  to,  the  next  ques- 
tion is  how  to  raise  the  necessary  funds.  This  is  a 
purely  financial  question,  which  deserves  even  fuller 
consideration  than  is  possible  within  our  space  limits. 
At  bottom  the  problem  of  raising  capital  funds  for 
betterments  is  of  the  same  general  character  as  the  prob- 
lem of  raising  the  initial  capital  funds  when  a  corpora- 
tion starts  business.  There  are,  however,  as  we  shall 
see,  some  important  variations  in  the  problem. 

The  sources  of  capital  funds,  whether  at  the  begin- 
nmg  or  during  the  corporation's  existence,  are  the  same 
as  have  already  been  given,  namely: 

(a)  The  active  managers  of  the  corporation. 

(b)  Surplus  earnings. 

(c)  Trade  creditors. 

(d)  Banks. 

(e)  The  investing  public. 

(f)  The  speculative  public. 

For  our  present  purpose  we  may  eliminate  sources 
(a),  (c)  and  (d).  There  is  nothing  to  be  said  with 
regard  to  them  that  has  not  already  been  said  in  Chapter 


BETTERMENT  EXPENSES 


365 


\'II.  There  remain:  source  (b),  from  which  the  funds 
may  be  obtained  by  one  of  two  methods,  either  direct 
appropriations  from  surplus,  or  abnormally  high  oper- 
ating expenditures;  source  (e),  which  may  be  reached 
either  by  the  issue  of  medium-term  notes  or  by  the  issue 
of  bonds;  and  source  (f)  from  which  funds  may  be  ob- 
tained by  the  sale  of  new  stock. 

197.  Appropriations  from  earnings. — The  safest  and 
surest  known  method  for  providing  for  betterments  and 
building  up  any  concern  is  by  making  appropriations 
out  of  earnings.     Expansion  that  is  financed  in  this 
manner  will  be  very  slow,  to  be  sure,  unless  the  profits 
of  the  concern  are  inordinately  large.     This  very  slow- 
ness, however,  is  in  some  respects  an  advantage.     It 
necessitates  a  gradual  growth,  a  kind  of  evolution  of 
the  business,  and  thus  automatically  provides  against 
waste  and  recklessness.     It  is  practically  certain  that 
any  concern  which  is  built  up  altogether  or  in  large 
part  by  means  of  appropriations  from  each  year's  sur- 
plus will  be  conducting  its  business  along  conservative 
lines.     That  it  is  not  impossible  by  this  method  to  con- 
struct in  time  an  immense  and  profitable  concern  is 
proved  by  the  history  of  two  of  our  great  industrials,  the 
Carnegie  Steel  Company  and  the  Baldwin  Locomotive 
Works.     The  Carnegie  Company  had  its  inception  in 
1871  in  an  insignificant  steel-making  plant  which  was 
Itought   with   a   few   thousand   dollars   that   Andrew 
Carnegie   and    his    associates    were    able    with    great 
(lifRcultv   at   that   time   to   command.     It   has   since 
expanded  until  it  is  to-day  worth,  as  a  gomg  concern, 
perhaps  a  half-billion  dollars;  and  all  that  expansion  has 
been  the  result  of  profits  slowly  turned  back  into  the 
business.     In  this  respect  the  history  of  the  Baldwin 
Locomotive  Works  is  closely  similar. 


If 


866 


COKPORATlOxX  FINANCE 


It 


s. 


198.  Objections  to  this  method,— Yet  in  spite  of 
these  great  successes  we  must  not  overlook  the  two 
obvious  disadvantages  of  this  method  of  obtaining  funds 
for  betterments.     The  first  and  most  vital  objection  is 
that  the  slowness  of  the  process  may  occasion  the  loss 
of  valuable  opportunities.    While  an  old,  conservative 
company  is  thus  gradually  acquiring  the  funds  neces- 
sary for  the  expansion  of  its  business,  it  may  well  be 
that  a  somewhat  more  daring  concern  may  borrow  the 
funds  necessary  for  expansion  and  thus  capture  the  op- 
portunity that  was  at  first  open  to  both  of  them. 
Conservatism  undoubtedly  is  a  business  virtue;  yet  for 
the  best  results  it  needs  to  be  mixed  with  a  strong  dash 
of  speculative  fervor.     The  second  objection  is  that  the 
ordmary  stockholder  in  any  concern  desires  to  enjoy 
the  profits  of  a  business  as  they  are  earned  and  objects 
strongly  to  having  those  profits  diverted  to  betterment 
expenses.     It  is  true  that  an  increase  in  the  corpora- 
tion's assets  is  an  increase  in  hi*'  assets,  for  he  is  part 
owner  of  the  corporation.     It  is  true,  also,  that  an  in- 
crease in  assets  will  be  to  some  extent  reflected  in  a  rise 
in  the  market  value  of  his  stock,  so  that  he  may  sell  out 
if  he  chooses  and  put  his  money  into  a  more  liberal  cor- 
poration.    This  last,  however,  is  not  a  wholly  satisfac- 
tory argument  to  the  stockholder,  for  market  values 
are  based  more  largely  on  earnings  and  dividends  than 
they  are  on  underlying  assets.     This  is  a  truth  that  will 
be  found  fully  illustrated  in  the  volume  on  Investment 
AND  Speculation.    Thus  the  body  of  stockholders  is 
apt  to  oppose  strenuously  a  reduction  in  their  dividends 
in  order  to  provide  for  betterments.    It  seems  to  them 
as  if  they  were  being  compelled  to  make  a  sacrifice  for 
the  benefit  of  future  stockholders. 
199.  The   attitude   of  stockholders.— An    example 


BETTERMENT  EXPENSES 


367 


that  was  conspicuous  a  few  years  ago  was  the  deter- 
mined struggle  on  the  part  of  minority  stockholders  in 
the  Wells-Fargo  Express  Company  for  larger  divi- 
dends. This  company  was  controlled  by  the  Harriman 
party,  and  Mr.  E.  H.  Harriman,  following  his  usual 
policy,  was,  as  it  seemed,  too  much  inclined  to  sacrifice 
dividends  to  financial  strength.  The  minority  stock- 
holders stated  that  the  Wells-Fargo  Company  had  been 
piling  up  an  enormous  surplus,  which  was  not  needed 
or  used  in  the  business,  but  was  invested  in  the  securi- 
ties of  other  companies.  The  majority  stockholders — 
that  is  the  Harriman  party — ^rejoined  that  the  security 
holdings  of  the  Wells-Fargo  Company  were  for  the 
sake  of  control  and  for  the  prevention  of  ruinous 
competition;  in  other  words,  that  earnings  had  been 
consistently  devoted  to  betterments.  The  undeniable 
facts  are  that  the  company  was  highly  prosperous,  was 
paying  rel^'tively  small  dividends  and  was  more  or  less 
harassed  by  a  body  of  dissatisfied  stockholders. 

The  objections  by  the  stockholders  in  such  cases  may 
be  induced  by  any  or  all  of  three  motives: 

(1)  They  may  simply  be  anxious  for  present  divi- 
dends, even  though  they  be  paid  at  the  risk  of  reducing 
the  corporation's  future  earnings  and  prosperity. 
Human  nature  is  so  constituted  that  to  almost  all  of  us 
$1  this  year  looks  better  than  $2  five  years  from  now. 

(2)  Some  of  the  stockholders  may  have  speculative 
tendencies  which  lead  them  to  desire  a  good  market 
price  and  a  quick  sale  for  their  stock — perhaps  with  the 
idea  that  after  a  while  the  dividends  will  be  cut  and  they 
will  be  able  to  repurchase  stock  at  much  lower  prices. 
This  motive  will  always  be  strong  when  many  of  the 
stockholders  belong  to  the  speculating,  rather  than  to 
the  investing  class.    Here  is  one  of  the  best  reasons 


■  r- 


868 


CORPORATION  FINANCE 


why  a  conservative  corporation  manager  will  desire  to 
put  his  stocks  on  an  investment  basis  from  the  very 
beginning,  if  possible. 

(3)  The  stockholders  in  a  corporation  which  has  a 
large  funded  debt  may  reason  that  whatever  sums  are 
diverted  from  dividends  to  betterments  go  to  increase 
the  security  and  the  value  of  the  corporation's  bonds 
rather  than  of  its  stock.  We  shall  have  occasion  to 
deal  with  this  motive  and  its  results  when  we  take  up  in 
Chapter  XXVIII  the  methods  of  manipulation  for  the 
benefit  of  the  body  of  stockholders.  It  is  enough  to  say 
here  that  this  motive,  although  narrowly  selfish,  is  still 
entirely  legitimate  and  often  has  great  weight. 

Wlierever  these  motives  are  at  work — and  some  or  all 
of  them  are  likely  to  be  strong  in  almost  any  body  of 
stockholders — objections  to  heavy  betterment  expendi- 
tures out  of  earnings  will  be  in  evidence. 

In  the  Wells-Fargo  case  the  protesting  stockholders 
however  disagreeable  they  might  make  themselves,  did 
not  have  much  influence  with  the  management,  because 
they  were  distinctly  in  the  minority.  It  often  happens, 
however,  that  the  active  managers  of  a  corporation  are 
more  prudent  or  more  farsighted  than  the  majority  of 
their  stockholders  and  for  the  good  of  the  corporation 
desire  to  pursue  a  policy  of  small  dividends  and  large 
betterment  expenses  which  would  not  be  supported  if  it 
were  clearly  presented  to  the  stockholders.  In  order  to 
attain  their  object  the  corporation  officers  must  keep  the 
stockholders  more  or  less  in  the  dark;  and  this  they  do 
by  the  very  simple  process  of  charging  expenditures  for 
betterments  imder  operating  expenses. 

200.  The  case  of  the  Lehigh  Volley  Railroad.— Tht 
history  of  the  I.ehigh  Valley  Railroad  so  well  illustrates 
the  workings  and  the  results  of  this  species  of  well-inten- 


BETTERMENT  EXPENSES 


369 


tioned  deceit  that  it  is  worth  a  rapid  review.  In  the 
year  1897  new  interests,  which  were  represented  in  the 
active  management  by  President  Walters,  came  into 
control  of  this  company.  The  five  years  following, 
1898  to  1902  inclusive,  were  a  period  of  remarkable 
development  and  prosperity  for  almost  all  the  railroads 
and  industrial  corporations  of  the  United  States,  and 
the  Lehigh  Valley  was  no  exception.  Gross  earnings 
from  operation  increased  25  per  cent;  the  revenue 
tonnage  increased  150  per  cent;  at  the  same  time  the 
average  freight  rate  per  ton  per  mile  showed  a  slight 
gain.  On  the  other  hand,  the  outlay  per  train  mile 
for  moving  this  tonnage  decreased.  Thus  earnings 
were  apparently  going  up  while  running  expenses  rela- 
tively were  decreasing,  and  a  largely  increased  net 
income  would  naturally  have  been  expected  to  follow. 
The  facts  were,  however,  that  the  gross  income  (not 
gross  earnings)  decreased  from  $6,800,000  in  1898  to 
$4,800,000  in  1901  and  $4,650,000  in  1902,  when  the 
anthracite  coal  strike  was  in  progress. 

iVn  inquiring  stockholder,  who  might  have  chanced 
to  consider  with  care  these  strange  and  anomalous 
figures,  would  perhaps  have  turned  to  the  balance  sheet 
of  the  company  in  the  expectation  of  finding  therein 
revealed  some  noteworthy  addition  to  assets  purchased 
out  of  earnings.  But  our  inquiring  friend  would  have 
been  disappointed.  He  would  have  found  the  compara- 
tive figures  of  the  important  assets  of  the  road  as 
follows: 

ASSETS 


1898 

Tost  of  Road $18,689,291.96 

Tost  of  Equipment 19,018,419.98 

SKuritics  owned 82,949,822.14 

r-VT— 84 


1902 
$18,689,291.98 
19,018,419.98 
39,800,209.80 


370 


CORPORATION  FINANCE 


The  only  change  here  is  an  increase  in  the  securities 
owned,  which  is  not  sufficient  in  amount  to  account  for 
all  that  apparently  should  have  been  saved  out  of  earn- 
ings. The  book  values  of  road  and  equipment,  it  will 
be  noticed,  have  not  been  changed. 

The  true  explanation  could  have  been  found  only  by 
analysis  of  the  operating  expenses  of  the  railroad.  In 
the  first  place,  the  proportion  of  total  operating  ex- 
penses to  gross  earnings  from  operations— or  operating 
ratio,  as  it  is  called— had  risen  from  70  per  cent  in  1898 
to  81  per  cent  in  1902.  As  a  normal  railroad  operating 
ratio  would  be  60  to  65  per  cent,  it  is  evident  that  this 
extraordinarily  high  ratio  of  the  Lehigh  Valley  in  1902 
indicated  one  of  two  things:  either  bad  management  or 
inflated  operating  expenses.  We  may  get  some  light 
as  to  which  was  responsible  in  the  present  case  by  a  slight 
further  analysis  of  operating  expenses.  In  1895 
22  5-10  per  cent  of  the  total  operating  expense  went  to 
maintenance  of  way;  in  1902  over  40  per  cent.  In  1895 
the  average  train-load  was  384  tons;  in  1902,  467  tons. 
Evidently  large  sums  had  been  devoted  during  the 
interim  to  betterments  which  greatly  increased  the 
economy  and  efficiency  of  the  road's  management.  We 
are  now  informed  that  during  the  five  years,  1898  to 
1902,  all  new  equipment,  all  side-tracking  and  other 
expansions  of  track,  all  construction  of  bridges  and 
buildings,  all  reballasting  of  track  and  similar  items 
had  been  charged  to  operating  expenses.  Professor 
Edward  Sherwood  JMeade,  to  whose  searching  analysis 
we  are  indebted  for  much  of  the  information  here 
presented,  estimates  that  in  these  five  years  the  Lehigh 
Valley  under  IVfr.  Walters'  management,  spent  almost 
$13,000,000  on  betterment  expenses  which  ordinarily 
would  have  been  provided  for  by  new  issues  of  stock  or 


BETTERMENT  EXPENSES 


871 


bonds;  in  other  words,  the  $13,000,000  under  a  different 
management   would   have   been   distributed  to  stock- 

liolders. 

In  1902  a  new  management  came  into  power,  and  the 
report  for  the  fiscal  year  1903  shows  some  radical 
changes  in  accounting  methods.  Net  income,  for  in- 
stance, which  had  been  $4,650,000  the  preceding  year, 
suddenly  jumped  to  $8,300,000.  The  new  manage- 
ment, after  appropriating  $1,250,000  for  betterments 
and  after  paying  all  fixed  charges,  was  still  able  to  show 
over  $2,000,000  available  for  dividends;  this,  in  the  face 
of  a  defiicit  after  allowing  for  fixed  charges  the  pre- 
ceding year  of  over  $1,200,000.  In  1904  the  stock  was 
given  a  dividend  of  1  per  cent.  In  1905  it  was  put  on 
a  4  per  cent  basis.  Between  1901  and  1908  the  gross 
earnings  of  the  Lehigh  Valley  were  increased  about  83 
per  cent.  Its  net  earnings  were  considerably  more 
than  doubled,  and  yet  its  fixed  charges  were  increased 
scarcely  at  all.  The  figures  below  tell  the  whole  story 
of  this  remarkable  growth  more  plainly  than  it  could  be 
put  in  words: 


1908  1901  Increane 

Miles  operated 1,447  1,882  65 

Gross  earnings $86,510,154  $26,688,588  $8,826,621 

Gross,  per  mile 24,500  19,800  5,200 

Net  earnings   12,188,582  5,765,113  6,418,469 

Net,  per  mile 8,420  4,170  4,250 

Chgs,  less  other  inc .. .      4,818,008  4,864,800  448,208 

Charges,  per  mile 8,820  8,150  170 

Surplus    7,870,674  1,400,818  5,970,261 

Surplus,  per  mile 5,100  1,018  4,087 

Now,  what  is  the  meaning  of  these  facts  and  figures? 
In  the  first  place,  it  is  plain  that  the  road  was  in  poor 


872 


CORPORATION  FIxVAxNCE 


If 
i 


I 


i' 


condition  prior  to  Mr.  Walters'  administration  and  that 
he  left  it  in  such  excellent  condition  that  its  net  earnings 
afterward  showed  a  phenomenal  increase.  There  can 
be  no  question  but  that  the  millions  which  Mr.  Walters 
poured  into  the  property  were  wisely  spent  and  have 
since  ])een  efficiently  administered.  To  an  investor  or 
corporation  manager  this  review  should  be  an  inspiring 
story  of  honest  profits  ably  secured. 

Nevertheless,  it  must  be  admitted  that  Mr.  Walters' 
policy,  so  far  as  the  stockholders  were  concerned,  was 
one  of  evasion  and  deceit.  True  it  is  that  whatever 
he  did  was  intended  for  their  own  best  interests;  yet  it 
is  also  true  that  they  would  not  always  have  approved 
of  his  actions  if  they  had  known  exactly  what  was  going 
on.  We  do  not  need  to  enter  into  the  ethics  of  the  case. 
It  is  plain,  however,  that  the  stockholders,  from  any  or 
all  of  the  motives  we  have  previously  mentioned,  might 
with  justice  have  objected  to  Mr.  Walters'  course.  As 
a  matter  of  fact,  they  did  finally  become  alive  to  the 
situation  and  helped  in  bringing  a  new  management 
into  power. 

201.  Policy  of  the  Union  Bag  and  Paper  Company. 
— Another  illustration  of  large  operating  expenses 
being  used  to  beguile  stockholders  into  putting  a  large 
portion  of  earnings  into  betterments  is  to  be  found  in 
the  recent  history  of  one  of  the  smaller  trusts,  the  Union 
Bag  and  Paper  Company.  In  a  review  of  this  com- 
pany's condition,  recently  issued,  we  find  the  following 
remarks: 

Benefit  is  now  being  derived  from  the  liberality  with  which 
outlays  for  repair  work,  maintenance  and  improvements  have 
been  made.  Since  the  formation  of  the  company  nine  years  ago, 
about  $8,000,000  have  been  expended  in  construction,  purchaw 
of  woodlands,  etc.,  in  addition  to  requiremrnts  for  ordinary  r<- 


BETTERMENT  EXPENSES 


373 


pairs  and  maintenance  which  liave  been  charged  directly  to 
operating  expenses,  and  also  in  addition  to  the  amounts  ex- 
ptiulid  in  1906  for  the  property  of  the  Gres  Falls  Company 
and  that  of  the  Allen  Bros.  Company.  All  told  over  $6,000,000 
have  been  expended,  since  the  company's  incorporation,  for  ad- 
ditional property  and  new  construction,  and  the  company  has 
increased  its  capital  obligations  only  to  the  extent  of  $2,439,- 
000.  While  the  company's  physical  and  producing  capacity 
has  been  undergoing  improvement,  i.^  .^nancial  position  has  also 
been  bettered,  net  working  capital  ht  ving  been  increased  in  the 
past  four  years  by  approximately  $1,068,000  or  about  100 
per  cent. 

202.  Borrowing  funds  for  betterments. — The  third 
means  of  raising  funds  for  betterments  is  through  issues 
of  medium-term  notes.  It  is  not  necessary  to  consider 
this  method  with  great  care,  inasmuch  as  it  has  already 
been  discussed  in  Chapter  VIII.  The  examples  given 
there  were  sufficient  to  show  the  dangers  of  this  method. 
Obviously  it  cannot  properly  be  utilized  except  to  pro- 
vide for  betterments  which  are  practically  certain  to 
yield  large  and  immediate  profits;  otherwise  the  corpo- 
ration will  be  incurring  obligations  that  must  be  met 
out  of  income  and  that  will  perhaps  become  exceedingly 
dangerous. 

A  much  better  method,  generally  speaking,  of  secur- 
ing the  funds  for  permanent  betterments  is  by  means  of 
long-term  bonds.  As  has  been  previously  explained, 
large  well-established  corporations  do  not  usually  expect 
to  pay  off  these  bonds  when  they  fall  due,  but  plan  to 
refund  them  by  new  issues.  In  other  words,  what  they 
actually  do  is  to  incur  a  permanent  fixed  charge.  Now 
if  a  betterment  is  of  such  a  character  that  it  is  practically 
certain  to  produce  profits  year  after  year  larger  than 
the  fixed  charges  assumed  in  order  to  make  the  better- 


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ment,  it  is  no  doubt  good  policy  to  raise  the  necessary 
funds  by  the  issue  of  long-time  obligations. 

203.  Policy  of  the  Pennsylvania  Railroad,— Th^  set- 
tied  policy  of  the  Pennsylvania  Kailroad  is  the  best 
known  and  most  consistent  illustration  of  the  working 
of   this  principle.    This  company,  it  is  understood, 
separates  all  its  betterment  expenses  into  the  two  classes 
previously  named :    First,  those  which  wUl  in  all  human 
probability  result  in  a  permanent  saving  or  profit  more 
than  equal  to  interest  on  the  funds  thus  invested;  second, 
those  which  will  probably  prove  profitable,  but  which 
may  or  may  not  yield  profits  in  the  immediate  future. 
To   the   first  group   the   Pennsylvania   management 
assigns  such  betterments  as  shortening  and  straighten- 
ing a  line,  cutting  down  grades,  providing  new  equip- 
ment where  an  increase  in  traffic  is  certain,  and  so  on; 
to  the  second  class  they  assign  such  betterments  as  a 
large  part  of  the  tunnel  construction  in  and  around  New 
York  City,  providing  new  equipment  for  a  hoped-for  in- 
crease in  traffic,  operating  passenger  stations,  and  so  on. 
The  Pennsylvania  Railroad's  custom  is  to  pay  for  all 
betterments  of  the  first  class  by  bond  issues  and  for 
all  betterments  of  the  second  class  by  appropriations 
from  surplus.    Thus  the  stockholders  secure  at  the  same 
time  the  maximum  of  returns  and  the  maximum  of 
safety.    It  is  the  ideal  policy  as  regards  betterments 
and  will  no  doubt  be  more  gene  -ally  adopted  in  the 
future  by  railroad  and  industrial  corporations. 

To  illustrate  its  workings  in  the  concrete  case  of  the 
tunnel  into  New  York  City  and  accompanying  improve- 
ments, the  following  figures  are  presented.  Up  to  the 
end  of  1908  the  total  cost  of  the  tunnel  extension,  as 
shown  by  the  annual  reports,  was  $7T,.528,664,  of  which 
only  60  per  cent  had  been  capitalized.    The  total  cost 


BETTERMENT  EXPENSES  375 

is  covered  by  the  following  charges  on  the  books  and 
appropriations  of  surplus  profits: 

Cost  on  Books,  December  31,  1908 $46,528,664 

Charged  to  surplus  income  of  1908 1,000,000 

Charged  to  profit  and  loss  account  in  1907 7,000,000 

Charged  to  profit  and  loss  account  in  1906 13,000,000 

Charged  to  profit  and  loss  account  in  1905 5,000,000 

Charged  to  profit  and  loss  account  in  1903 5,000,000 

Total  cost  of  tunnel  extension  at  end  of  1908. .   $77,628,664 

The  cost  on  the  books  given  above  is  the  figure  at 
which  the  Pennsylvania  Railroad  carried  the  work 
then  accomplished  as  an  asset.  But  in  1908  the 
Pennsylvania  Railroad  proper  required  the  lines  west 
of  Pittsburg  to  assume  a  part  of  the  burden  and  accord- 
ingly the  Pennsylvania  Company  turned  over  $10,000,- 
000  in  securities,  deducting  the  value  thereof  from 
its  profit  and  loss  surplus.  Assuming  that  the  income 
derived  from  these  securities  will  defray  the  interest 
charges  on  $10,000,000  of  the  capital  invested  in  the 
tunnel,  the  Pennsylvania  Railroad  will  have  to  look  to 
the  operation  of  that  property  to  yield  fixed  charges 
upon  capital  borrowings  for  that  purpose  of  only  about 
$36,500,000. 

204.  General  conclusions  as  to  the  financing  of  better" 
ments. — The  only  remaining  method  to  consider  of  se- 
curing funds  for  betterments  is  by  means  of  stock  issues. 
The  comparative  merits  of  increasing  capitalization  by 
means  of  stock,  as  compared  with  bond,  issues  are  too 
obvious  to  need  much  discussion.  A  bond  issue  is  a 
cheaper  means  of  getting  the  necessary  fimds,  for  bonds 
can  always  be  sold  to  better  advantage  than  stock  which 
yields  the  same  return;  on  the  other  hand,  bond  issues 


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are  objectionable  in  so  far  as  they  tend  to  increase  the 
fixed  charges  and  thereby  imperii  tlie  safety  of  the  com- 
pany. New  stock  issues  are  safe  enough,  but  of  course 
tend  to  reduce  the  rate  of  distribution  on  the  stock  al- 
ready outstanding.  We  may,  perhaps,  lay  down  this 
general  rule,  that  betterments  of  the  second  class— fol- 
lowing the  classification  we  have  given— ought  to  be 
financed  either  out  of  surplus  or  by  means  of  new  stock 
issues;  betterments  of  the  first  class  ought  to  be  financed 
by  bond  issues,  or  in  rare  cases  by  issues  of  medium-term 
notes. 

In  what  is  said  with  regard  to  the  financing  of  better- 
ments, as  in  all  other  general  questions  of  corporation 
policy,  we  must  be  content  with  broad  conclusions. 
Corporation  managers  who  differ  from  the  general 
principles  here  laid  down  are  not  necessarily  to  be  con- 
demned offhand.     They  may  have  good  reasons  which 
do  not  appear  on  the  surface.     Every  business  man 
must  base  has  actions,  not  so  much  on  general  principles, 
as  on  the  important  concrete  factors  that  confront  him! 
At  the  same  time  it  is  also  true  that  a  clear  understand- 
ing of  these  principles  and  of  the  practice  of  large  cor- 
porations will  aid  the  corporation  manager  in  handling 
more    intelligently    and    more    successfully    whatever 
peculiar  and  difficult  problems  arise  before  him. 


CHAPTER  XXIV 

CREATION  AND  USE  OF  A  SURPLUS 

205.  Definition.— One  of  the  most  talked  about  topics 
in  the  field  of  Corporation  Finance  is  the  "surplus," 
its  formation  and  its  management.  Yet  in  spite  of  all 
the  discussion,  there  is  still  a  great  deal  of  confusion 
even  in  the  minds  of  lawyers  and  men  familiar  with 
financial  affairs  as  to  what  a  surplus  is  and  what  it  is 
^n)()d  for.  The  main  principles  that  govern  the  manage- 
ment of  surplus  are  not  different  from  those  which 
should  control  the  management  of  other  capital  funds, 
and  are  simple  enough  to  seem  obvious  when  they  are 
once  clearly  stated.  That  they  are  not  always  clearly 
comprehended,  however,  is  proved  by  the  loose  writing 
and  thinking  with  regard  to  the  subject  that  is  so  often 
manifest. 

A  brief  satisfactory  definition  of  surplus  is  that  it 
is  the  difference  between  the  assets  and  the  obligations 
of  a  corporation,  including  under  "obligations"  all  the 
outstanding  stock  of  the  corporation,  as  well  as  its  re- 
serves and  debts.  Suppose,  for  instance,  that  we  have 
a  corporation  with  assets  of  all  kinds,  having  a  total 
hook  valuation  of  $1,000,000,  and  having  6n  the  other 
side  of  the  account  debts  represented  by  accounts  pay- 
able, bank  loans,  notes  and  bonds  of  $500,000,  deprecia- 
tion and  other  reserves  of  $50,000  and  outstanding  cap- 
ital stock  amounting  to  $250,000;  it  is  evident  that  the 
corporation  must  have  secured  $200,000  of  its  assets 
from  some  other  source  within  the  business;  and  that 

877 


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source  we  call  surplus.  The  surplus  account,  as  is  ex- 
plained in  the  volume  of  Accounting  Pkactice  ap- 
pears  on  the  liability  side  of  the  balance  sheet,  because 
It  IS  an  amount  for  which  the  corporation  must  render 
an  account. 

206.  Four  sources  of  surplus.— In  our  discussion  of 
the  corporation's  surplus,  we  will  consider: 

(a)  How  it  is  obtained. 

(b)  What  is  done  with  it. 

(c)  Its  uses  and  management. 

One  possible,  though  very  unusual,  means  by  which  a 
corporation  obtains  a  surplus  is  by  inheritance.     Take, 
for  instance,  a  corporation  which  is  a  consolidation  of 
two  companies,  each  having  a  surplus  of  its  own.     The 
consolidation  may  conceivably  simply  guarantee  the 
bonds  and  other  outstanding  debts  of  the  subsidiary 
companies,  may  issue  dollar  for  dollar  in  stock  for  the 
stock  of  the  subsidiary  companies  and  may  transfer  the 
former  surpluses  bodily  to  its  own  accounts.    As  we 
have  seen  in  our  study  of  the  formation  of  consolida- 
tions, however,   (Chapter  XIV),  the  new  corporation 
will  usually  issue  securities  far  in  excess  of  the  market 
value  of  the  assets  of  flie  old  companies.     The  con- 
solidation, therefore,  will  not  only  not  start  out  with  a 
surplus  usually,  but  will  be  compelled  greatly  to  over- 
value  its  assets  in  order  to  make  a  balance  sheet  possible. 
We  may  dismiss  this  first  possible  source  of  surplus, 
then,  with  the  statement  that  it  is  too  uncommon  to  be 
worth  Oiscussion. 

The  second  source  of  surplus,  which  also  is  rather 
unusual,  is  the  selling  of  the  corporate  stock  or  bonds 
above  par.  Evidently  the  corporation  in  such  a  case 
receives  a  sum  of  money  greater  in  amount  than  the 
obligations  which  it  incurs.    Now  this  extra  sum  may 


CUEATION  AND  USE  OF  SURPLUS 


379 


be  handled  by  an  accountant  in  three  or  four  different 
ways.  One  way  is  to  include  it  in  the  corporation's  sur- 
plus account.  The  propriety  of  this  method  may  be 
disputed,  but  this  is  an  accounting  rather  than  a  finan- 
cial question. 

A  surplus  may  originate,  in  the  third  place,  in  whole 
or  in  part  from  the  sale  of  a  corporation's  fixed  or  semi- 
fixed assets.  Thus  if  a  manufacturing  company  owns 
a  plant  which  has  become  obsolete  and  worthless  for 
manufacturing  purposes,  and  the  value  of  which  has 
been  fully  covered  by  a  depreciation  reserve — in  other 
words,  written  off  the  books— and  afterwards  sells  this 
plant,  the  sum  resulting  would  go  into  the  surplus  ac- 
count. Of  course,  the  reader  will  understand  that  if  the 
value  of  the  plant  in  such  a  case  had  not  been  written  off 
the  books,  but  was  still  included  in  the  corporation's  bal- 
ance sheet,  the  only  effect  of  its  sale  would  be  a  transfer 
of  the  amount  received  from  the  property  account  to 
cash  or  notes  receivable  or  whatever  was  taken  in  pay- 
ment for  the  plant. 

A  similar  source  of  surplus  is  a  revaluation  of  the 
fixed  assets  of  a  corporation  when  the  revaluation  shows 
an  increase  in  their  value.  This  increase  would  nat- 
urally be  represented  on  the  liability  side  of  the  balance 
sheet  by  a  corresponding  gain  in  the  surplus.  Gen- 
erally speaking— and  it  must  be  remembered  that  there 
are  some  exceptions  to  this  rule — an  upward  revaluation 
of  assets  is  not  in  accordance  with  correct  accounting 
or  financial  principles.  Therefore,  this  fourth  source 
of  surplus  is  not  commonly  found. 

207.  The  fifth  source— saving.— This  brings  us  to 
the  fifth  and  most  common  source  of  surplus,  namely, 
saving  from  income.  The  uses  to  which  income  should 
he  ])ut  have  been  discussed  at  some  length  in  Chapter 


880 


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COHPOKATION  FINANCE 


XXI ;  and  the  final  uses,  after  the  fixed  charges  and  re 

r„T  "•."  ""=?  ^'"''"^  '"'■  -««  found  to  b?di'^ 
dends  and  surplus.    It  »iU  do  no  harm  to  reiterate  th. 
^portant  principle  there  laid  down  that  the  dividend 
of  practically  every  corporation  should  be  maintatoed 

tuatmg  dividends  destroy  the  confidence  of  the  invest- 
mg  pubhc  and  greatly  reduce  the  credit  of  thelrlra- 
to  below  what  it  might  possess.     The  proper  pE 
with  few  exceptions,  is  to  ascertain  the  minimum  ni 
earamgs  of  a  company  in  the  years  of  greatest  depredl 
l.on  and  rigidly  hold  the  dividends  It  or  b<^w  Xt 

lerred  to  the  company's  surplus  account. 

That  this  method  of  forming  a  surphis  may  build  it 
up  w,th  great  rapidity  is  shown  by  the  record  of  th 
great  mdustnal  concern,  the  Standard  Oil  Company 

Sus  Tafo  TTT'  *'/  ^""^  appropriated  to^u': 
plus  and  to  dividends,  and  the  totals  of  each  item  for 
seven  year,  are  as  foUows: 


Year  n^j,,  ^  Surplut 

1907 :::;:::: 'S'ZCI    ^'^'^''     «*«'««*.««>• 

1905    TAlltl  ^^^^^30  43.786.931 

1904  :: ll'^'l^'l  •^^^S.SSO       i8.m.03fi 

^*'^^^^3  43.851.956       20.761.407 

•A^nnl-  ■  ■; ■. 9S13^0,,0n  ^279.258.980  ^^^^, 

Approximated;  not  reported  after  1906. 

*W^Ind?nT''f  •""*  '"''  '''"™-  ">«  proportion  of 
dividends  paid  will  vary  with  the  fluctuations  in  earn- 


CREATION  AND  USE  OP  SURPLUS 


381 


ings.  The  greater  those  fluctuations  the  more  rapid  wUl 
be  the  increase  in  surplus.  The  converse  proposition 
IS  that  a  stable  rate  of  earnings  makes  unnecessary  the 
creation  of  a  big  surplus. 

208.  Policy  of  the  " trusts r-Prohssor  Edward  S. 
Meade  s  weU-known  volume  on  "Trust  Finance"  gives 
the  result  of  a  careful  study  of  the  dividend  and  surplus 
policy  at  the  beginning  and  during  the  existence  of  all 
our  important  mdustrial  combinations  or  "trusts  "  The 
prime  object  of  the  managers  of  almost  all  these  com- 
binations at  the  beginning.  Professor  Meade  points  out. 
was  to  pay  dividends  and  thereby  encourage  the  sale  of 
stock.  They  were  therefore  averse,  as  a  rule,  to  ap- 
propriating any  considerable  amounts  to  the  surplus  ac- 
count. They  even,  in  some  cases,  incurred  a  deficit  in 
order  to  pay  dividends.  Professor  Meade  computes 
that  twenty-six  important  consolidations,  which  he  has 
studied  with  especial  care,  earned  in  the  four  years 
1898-1901,  $150,201,890.    He  says: 

This  amount,  although  large  in  the  aggregate,  represents 
but  little  more  than  8  per  cent  per  annum.  It  would  appear, 
as  already  stated,  that  every  consideration  of  prudence  would 
incline  the  directors  of  these  companies  to  reserve  practically 
all  their  profits  in  order  to  strengthen  the  financial  position  of 
their  companies.  So  far  from  following  the  path  of  prudence. 
however,  61.9  per  cent— almost  two-thirds  of  these  profits- 
were  paid  out  in  dividends,  leaving  88.1  per  cent  for  the  sur- 
plus reserve.  The  inadequacy  of  this  reserve  may  be  better 
understood  when  it  is  compared  with  the  outstanding  capital 
"hose  permanent  value  it  was  intended  to  secure.  A  reserve  of 
only  4.2  per  cent  is  the  net  result  of  the  operations  of  three 
years. 

The  industrial  trusts  are  excellent  examples  of  cor- 
porations which  for  reasons  of  their  own  were  reluctant 


882 


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CORPORATIOxV  FINANCE 


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to  keep  dividends  down  to  a  conservative  basis  and  to 
create  large  surpluses.     The  results  of  their  imprudence 
are  familiar  to  most  of  us— perhaps  entirely  too  familiar 
to  some.    The  common  and  preferred  stock  of  most  of 
these  companies  received  dividends  for  a  few  years  but 
at  the  first  hint  of  trade  aid  financial  depression,  earn- 
mgs  fell  off,  dividends  were  stopped  and  the  market 
prices  of  the  stocks  dropped  with  a  thud.    We  have  here 
presented  an  impressive  lesson  that  ought  to  be  masteri^d 
by  every  corporation  director  and  stockholder— the  les- 
son that  in  times  of  plenty  provision  should  be  made 
through  creation  of  an  adequate  uirplus  account  out  of 
income,  for  the  seasons  of  famine  that  are  sure  to  come. 
209.  How  should  surplus  he  invested.~We  have  next 
to  consider  what  form  the  surplus  of  a  corporation 
should  take,  or,  in  other  words,  how  it  should  be  invested. 
Its  possible  forms  or  uses  are  as  numerous  as  the 
uses  to  which  the  original  capital  funds  of  a  corporation 
may  be  put,  and  may  be  classified  under  the  foUowinff 
heads: 

(a)  Cash. 

(b)  Securities. 

(c)  Decrease  of  current  liabilities. 

(d)  Sinking  fund. 

(e)  Increase  in  stock  of  raw  materials  or  finished 
products  on  hand. 

(f)  Betterments. 

(g)  Extensions  and  additions  to  fixed  assets. 

It  goes  without  saying  that  the  surplus  should  be  used 
to  strengthen  the  weak  spots,  whatever  they  may  be,  in 
the  corporation's  capital  equipment.  We  can  be  some- 
what more  specific,  however. 

210.  The  surplus  as  n  ''rain?/  day  fund.*'— There  are 
two  distinct  and  opposed  opinions  as  to  the  true  function 


CREATION  AND  USE  OF  SURPLUS 


383 


ol  u  surplus;  one,  that  it  should  be  merged  with  the  rest 
of  the  corporation's  capital  funds;  the  other,  that  it 
should  be  set  aside  as  an  insurance  against  future  losses. 
Let  us  first  consider  the  justification  and  the  results  of 
tills  second  opinion.    Its  advocates  base  their  case  on  the 
assertion  that  the  original  investment  of  capital  funds 
should  be  sufficient  to  carr  on  properly  all  the  business 
of  the  company;  if  these  funds  are  not  sufficient,  then 
tliey  should  be  increased  by  borrowing  or  by  bringing 
in  new  stockholders,  not  by  saving  out  of  profits.    The 
arguments  in  favor  of  providing  funds  for  betterment 
by  borrowing,  rather  than  by  saving,  have  already  been 
given  and  have  been  found  to  have  considerable  weight. 
The  advocates  of  this  opinion  are  convinced  of  the  ad- 
visability of  maintaining  dividends  at  a  stable  rate  and 
conceive  it  to  be  the  true  function  of  a  surplus  account 
to  equalize  the  dividends  over  a  series  of  years.     In  other 
words,  the  surplus  account  should  be,  in  their  view,  as 
it  has  well  been  called,  simply  a  "rainy  day  fund,"  to 
be  drawn  upon  for  dividends  whenever  the  necessity 
arises. 

It  follows,  if  this  opinion  is  correct,  that  the  surplus 
ought  to  take  the  form  of  cash  or  something  that  may 
nadily  be  turned  into  cash,  for  example,  securities. 
Otherwise,  it  will  not  be  readily  available  for  dividends 
in  periods  of  financial  stress  when  it  is  most  likely  to  be 
needed.  It  is  true,  to  be  sure,  that  a  surplus  may  be  in- 
vested in  permanent  assets  and  yet  be  treated  as  a  "rainy 
(biy  fund,"  for  these  assets  may  be  made  the  basis  of 
temporary  loans  to  the  corporation.  The  objection  here 
is  that  it  is  tmcertain  whether  such  loans  can  be  obtained 
"lien  they  are  most  needed  and,  moreover,  it  is  unsafe 
to  base  tempornrv'  loans  on  a  corporation's  fixed  assets. 
On  the  whole,  then,  we  may  say,  that  if  the  surplus  ac- 


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count  IS  to  be  regarded  simply  as  a  kind  of  reservoir  in 
which  future  dividends  for  lean  years  are  to  be  stored 
that  reservoir  should  be  filled  with  cash  or  easUy  market- 
able securities. 

The  chief  exponents  of  this  policy  are  the  great 
-t-nglish  and  German  shipping  companies,  particularly 
the  Cunard  Company  and  the  Hamburg- American 
Line.  The  former  company  is  said  to  have  nearly  one- 
third  of  its  total  assets  invested  in  securities  which  have 
no  direct  connection  with  its  shipping  business.  If  tiie 
company  runs  into  a  period  of  intense  competition  dur- 
ing which  it  cannot  earn  dividends,  or  should  it  sustain 
severe  losses,  enough  securities  would  be  sold  to  maintain 
the  regular  dividend  rate.  There  are  obvious  advan- 
tages m  this  course;  on  the  other  hand,  there  are  disad- 
vantages equally  obvious  and  for  most  corporations  of 
controlling  importance. 

The  first  disadvantage  is  that  to  build  up  a  cash  sur- 
plus is  almost  a  waste  of  that  much  capital.     It  is  a 
waste  because  capital  in  that  form  earns  next  to  nothing. 
If  it  is  kept  as  a  permanent  cash  balance  it  may,  to  be 
sure,  draw  interest  at  2  or  8  per  cent,  or  in  exceptional 
cases,  even  3'/2  per  cent;  but  this  is  a  totally  inadequate 
return  on  an  industrial  investment.     If  the  surplus  is 
in  the  form  of  marketable  securities  the  case  is  almost 
as  bad;  for  the  only  securities  that  are  marketable  in 
times  of  stringency  are  high  grade  bonds  which  do  not 
yield  above  taxes  more  than  SVi  per  cent  or  4  per  cent 
at  the  outside.     As  the  second  disadvantage,  it  must  be 
borne  in  mind  in  this  cfmnection  that  funds  so  invested, 
though  safe  enough  from  the  corporation's  standpoint, 
do  not  give  the  corporation  stockholder  safety  sufficient 
to  compensate  for  the  small  yield.     Wliat  is  meant  by 
this  statement  is  that  the  surplus,  however  invested,  is 


CREATION  AND  USE  OF  SURPLUS  385 

part  of  the  corporation's  capital  and  would  be  swallowed 
up  by  the  corporation's  creditors  in  case  of  bankruptcy. 

hus  the  surplus  goes  to  protect  the  creditor  rather  than 
tl^  stockholder.  The  stockhohler  would  be  much  better 
off,  so  far  as  safety  is  concerned,  if  his  portion  of  the 
surplus  were  turned  over  to  him  individually  and  he 
would  himself  buy  good  securities  with  the  proceeds 

211.  Putting  the  surplus  hack  into  the  property.- 
Having  these  disadvantages  in  view,  corporation  man- 
agers m  this  coimtry  have  almost  universally  put  the 
s...  plus  of  their  corporations  back  into  the  property 
Sometimes  it  is  used  to  increase  the  cash  balance  wher^ 
more  cash  is  really  needed  in  the  business,  or  to  buy 

n  Loth  hese  cases  however,  the  object  is  not  to  separate 
.surplus  from  the  business,  as  it  is  when  the  rainy  day 
un.l  IS  formed,  but  to  make  it  productive  in  the  bus  ness 
Sometimes  it  goes  into  betterments,  as  explained  in  the 
prcviou.  chapter,  or  into  extensions  or  into  some  other  of 
e  seven  forms  mentioned  above.     Just  which  form 
shall  be  chosen  by  the  corporation  management  depends 
on  cc.ns.derat.ons  which  have  already  been  discuss'Id  in 
tlH'  chapter  on  "Investment  of  Capital  Funds."     As  a 
'••'"nal  return  on  capital  invested  in  commercial  enter- 
•nses  m  this  country  M.,uld  run  from  G  per  cent  on  up, 
.s  evident  that  as  a  rule  the  investment  of  surplus  in 

Perhaps  the  stockholder  may  object  at  this  point  that 

'"  surplus  ,s  taken  from  the  profits  which  ought  to  be 

'■med  over  to  him.     The  objection  is  superficial  and 

'•'-Is  to  take  mtn  account  the  various  mt HhmIs  by  which 

;'  surplus  may  be.  and  in  the  end.  must  be,  distributed 

vo  the  corporation  stockholders.     Some  of  these  methods 


I  i' 


m 


»8G 


CORPORATION  FINANCE 


are  not  well  understood;  indeed  it  is  doubtful  whether 
half  the  stockholders  in  business  corporations  realize 
how  or  when  their  surplus  is  distributed  to  them.  This 
is  the  interesting  topic  which  will  be  the  subject  of  our 
next  chapter. 


i 


fit. 
tiff 

If 

11: 

i: 


CHAPTER  XXV 

DISTRIBUTION  OF  THE  SURPLUS 

212.  Efect  of  a  surplus  on  assets  and  dividends.— 
Ordinarily,  as  stated  in  the  preceding  chapter,  a  sur- 
plus IS  formed  out  of  savings  from  income  and  is  in- 
vested m  the  capital  assets  of  the  corporation.     Thus  it 
becomes  merged  at  once  with  the  capital  funds.     The 
average  stockholder  feels  that  it  is  lost  to  him.    He  sees 
to  be  sure,  that  the  assets  of  the  corporation  are  increased 
hy  .he  formation  of  a  surplus,  and  he  will  admit  prob- 
ably, if  you  pres«  him,  that  theoretically  this  increase  in 
assets  IS  a  good  thing  for  the  corporation  and  for  every 
stockholder  and  tends  to  increase  the  value  of  his  stock, 
llie  admission  however,  is  apt  to  be  grudgingly  made 
and  probably  does  not  disturb  the  stockholder's  convic- 
tion that  whatever  sums  are  devoted  to  surplus  are  taken 
out  of  the  pockets  of  the  owners  of  the  corporation.     He 
sees  how  these  sums  are  taken  away  from  him,  but  does 
not  see  clearly  in  what  form  they  come  back  to  him. 
1  le  object  of  this  chapter  is  to  explain  the  methods  by 
wimh  the  surplus  may  be  and  generally  is  returned. 

It  has  already  been  mentioned-and,  for  that  matter. 
■s  sclf-evident-that  surplus  wisely  invested  in  capital 
assets  increases  the  earning  power  of  the  corporation  and 
t urefore  its  ability  to  pay  large  dividends.  Moreover. 
tl'e  surplus  when  properly  invested  so  as  to  extend  the 
sales  of  the  corporation  or  its  ownings  of  raw  materials. 
-r  Its  control  over  competitive  plants,  tends  strongly  to 
make  earnings  more  stable,  and  therefore  to  make  prac- 

887 


;j88 


CORPORATION  FINANCE 


hi 


M 
I 


t 


ticable  a  distribution  in  dividends  of  a  larger  proportion 
of  earnings.  This  is  a  point  not  often  alluded  to  and 
worth  a  word  of  explanation.  It  is  evident  that  gen- 
erally speaking  the  larger  the  business  a  concern  does, 
the  more  stable  and  dependable  will  be  its  earnings — for 
slight  local  fluctuations  up  and  down  will  almost  always 
balance  each  other.  If  a  big  jobbing  corporation  loses 
trade  for  local  reasons  in  one  section  of  the  country,  it 
may  reasonably  hope  that  gains  in  other  sections  will  at 
least  counterbalance  the  loss.  It  is  also  true  that  con- 
trol, even  partial  control,  over  the  prices  of  raw  materi- 
als or  of  unfinished  products  tends  to  make  earnings 
more  stable.  It  may  well  happen  for  these  reasons  that 
a  relatively  small  surplus  will  have  a  more  than  propor- 
tionate influence  on  a  corporation  dividend  rate — ^not  so 
much,  to  reiterate,  because  it  increases  earnings,  as  be- 
cause it  makes  them  more  uniform. 

Frequently — and  this  is  especially  true  of  a  close  co^ 
poration — no  individual  stockholder  would  be  able  to 
save  and  invest  to  such  good  advantage  as  the  corpora- 
tion can  do  for  him.  Take  once  more  the  famous  ex- 
ample of  the  Carnegie  Steel  Company.  Does  anyone 
suppose  that  any  single  stockholder  in  that  company 
would  have  become  as  wealthy  if  the  earnings  had  reg- 
ularly been  paid  out  to  the  stockholders  in  dividends 
instead  ot  being  put  back  year  after  year  into  the  prop- 
erty? Tlie  stockholders  did  not  receive  very  large  div- 
idends for  many  years,  and  some  perhaps  were  inclined 
to  complain  that  they  were  not  getting  the  returns  on 
their  investment  that  were  justly  due  them.  In  this 
ease  the  stockholders  were  never  given  any  considerable 
proportion  of  earnings,  nor  was  the  vast  surplus  of  tlie 
company  distributed,  except  to  a  limited  extent,  until 
the  sale  of  the  Carnegie  Steel  Company  in  1901  to  the 


DISTRIBUTION  OF  THE  SURPLUS 


389 


United  States  Steel  Corporation.  Then  the  extraor- 
dinary strength  and  riches  of  the  company  were  sudden- 
ly revealed.  Ahnost  a  half-billion  dollars  in  cash  or  sal- 
able securities  were  showered  upon  the  fortunate  stock- 
holders of  the  company.  Pittsburg,  like  a  night-bloom- 
ing cereus,  suddenly  blossomed  with  millionaires. 

213.  Distribution    through    stock    watering.— Th\s 
chapter  is  not  to  deal,  however,  with  the  distribution  of 
surplus  through  its  effect  on  dividends  or  through  the 
final  sale  of  the  company's  assets,  but  rather  with  the 
more  direct  and  usual  methods.    First  among  these 
methods  to  be  mentioned  is  the  declaration  of  an  extra 
stock  dividend.     In  the  year  1880  the  Chicago,  Rock 
Island  and  Pacific  Railroad  Company  was  a  highly  suc- 
cessful corporation  with  large  earning  power,  due  in 
part  to  the  fact  that  for  many  years  a  considerable  pro- 
portion of  the  earnings  had  been  put  back  into  the  prop- 
erty.   The  directors  of  the  corporation  thought  it  wise 
to  increase  their  dividend  payments,  and  yet  on  account 
of  the  popular  prejudice  against  large  railroad  earnings 
did  not  wish  to  increase  the  dividend  rate.     They  there- 
fore adopted  the  plan  of  consolidating  with  themselves 
a  small  subsidiary  railroad,  the  stock  of  which  they  al- 
ready owned;  they  paid  for  that  stock  and  for  the  stock 
of  the  Chicago,  Rock  Island  and  Pacific  Railroad  Com- 
pany by  an  immense  issue  of  stock  of  an  entirely  new 
corporation,   the  Chicago,   Rock   Island  and   Pacific 
Railway  Company.     This  stock  of  the  new  corpora- 
tion was  distributed  to  the  old  stockholders  in  the  pro- 
portion of  two  new  shares  to  one  old  share.     Then 
on  .ill  the  stock  outstanding  they  declared  and  main- 
tained a  dividend  rate  nearly  equal  to  what  had  pre- 
viously been  paid.     In  efFect  this  process  was  a  capital- 
ization of  a  surplus  of  the  corporation  and  a  distribution 


%m 


I 


390 


(  OUi'OU ATIOX  FINANCK 


:fe: 


!ii^ 


li\ 


I'- 


'if 


m^^^ 


k 


of  the  surplus  to  stockholders.  A  more  recent  instance 
of  somewhat  the  same  kind  is  the  well-known  Chicago 
and  Alton  deal,  which  is  discussed  in  Chapter  XXVIl. 

The  essential  feature  of  such  a  transaction  is  the  cap- 
italization of  surplus  and  distribution  of  this  extra 
capitalization  to  stockholders.  The  reader  may  inquire 
as  to  the  advantage  of  this  course.  Surely,  he  will  say, 
two  shares  of  a  total  capital  stock  of  $2,000,000  are 
worth  no  more  than  one  share  of  a  total  capital  stock  of 
$1,000,000.  The  two  shares  in  the  first  instance  repre- 
sent no  larger  proportion  of  assets  and  earnings  than 
the  one  share  in  the  second  instance.  This  reasoning  is 
plausible  and  true  so  far  as  it  goes ;  yet  the  fact  remains 
that  the  stockholders  gain  something  by  a  stock  dividend. 
In  the  first  place,  the  dividend  rate  is  kept  down  by 
this  means,  and  in  the  case  of  public  service  corporations 
public  hostility  is  to  some  extent  avoided.  In  other 
words,  the  stock  is  watered,  and  the  dividend  rate  main- 
tained. The  American  Telephone  and  Telegraph  Com- 
pany is  one  of  the  many  examples  of  companies  which 
have  thus  greatly  increased  their  capitalization  from 
time  to  time,  apparently  with  this  object  in  view.  A 
discussion  of  the  ethics  of  such  a  transaction  would  be 
interesting,  but  is  outside  the  scope  of  this  volume. 

In  the  second  place,  it  is  well  known  to  corporation 
managers  and  to  all  who  have  studied  the  stock  market 
with  any  care  that  two  sliares  of  stock,  each  paying  i 
per  cent  per  annum,  nill  have  a  combined  market  price 
higher  than  one  share  of  stock  paying  8  per  cent  per 
annum.  This  seems  a  curious  anomaly,  but  is  readily 
explained.  There  are  more  people  able  and  willing  to 
buy  low-priced  than  there  are  to  buy  high-priced  se- 
curities. Therefore,  tl>e  market  for  the  two  shares  in 
this  ilhistration  is  wider  than  the  market  for  the  one 


DISTRIBUTION  OF  THE  SURPLrS 


391 


share;  that  is  to  say,  the  demand  for  the  two  shares  is 
.somewhat  greater  and  therefore  their  combined  price 
will  be  higher. 

This  same  principle  leads  the  promoters  of  mining 
and  oil  and  other  highly  speculative  companies  to  fix  the 
par  value  of  their  shares  at  a  low  figure,  $10  or  $1  or  10 
cents,  or  even  as  low  as  1  cent.  Applying  the  principle 
to  stock  dividends  we  see  that  there  may  be  a  real  gain 
to  a  stockholder  in  an  increase  in  the  number  of  shares 
he  liolds,  even  though  there  is  no  change  in  the  amount 
of  dividends  he  receives. 

214.  Distribution  through  subscription  privileges. — 
We  are  ready  now  to  discuss  the  most  common  and  im- 
portant  method  of  distributing  a  surplus,  namely,  the 
granting  of  subscription  privileges  for  new  issues  of 
stock.  In  most  states,  as  the  reader  is  already  aware, 
stock  cannot  be  regarded  as  fully  paid  if  it  is  sold  for 
less  than  its  par  value.  No  state,  however,  makes  it 
obligatory  under  any  circumstances  to  sell  stock  at  more 
than  its  par  value;  yet  tlie  stocks  of  successful  corpora- 
tions which  are  able  to  maintain  stable  dividend  rates  of 
more  than  6  to  7  per  cent  per  annum,  almost  always 
have  market  values  higher  than  par.  Here  is  an  oppor- 
tunity for  the  corporation  directors,  if  they  see  fit,  to 
give  the  stockholders  a  valuable  privilege — the  privilege, 
namely,  of  buying  new  stock  issues  at  less  than  the 
market  prices. 

The  relative  advantages  of  providing  funds  for  im- 
provements and  extensions  of  property  by  bond  issues, 
l)y  stock  issues  and  by  appropriations  from  earnings, 
have  been  discussed  in  Ciiapter  XXII.  It  was  there 
laid  down  as  a  general  principle  that  provision  of  per- 
manent capital  funds  by  means  of  stock  issues  is  not  ad- 
visable unless  all  the  new  stock  is  taken  by  the  old  stock- 


392 


CORPORATIOxV  FINANCE 


it 


';  '*i 


■1 
ji--  ■ 

il 


holders.  This  condition  will  be  fulfilled,  however,  when 
he  old  stockholders  are  given  the  valuable  privilege  of 
huying  the  new  stock  at  less  than  its  market  value,  and 
under  such  cu-cu,nstances  the  raising  of  additional  capi- 
tal  funds  by  stock  issues  is  a  very  common  and  on  the 
whole  commendable  method.  We  have  now  to  consider 
exactly  how  surplus  may  be  distributed  by  means  of 
these  privileged  subscriptions"  and  how  each  stock- 
holder may  best  secure  his  share  of  the  advantages  that 
should  accrue  to  him. 

215.  An  opportunity  thus  given  for  cheap  investment 
-Ihe  privilege  of  buying  a  certain  amount  of  stock 
below  the  market  price  enables  the  stockholder,  if  he 
chooses    to  make  a  new  investment  on  exceptionally 
lavorable  terms.     For  instance,   in   1902  the   Illinois 
Central  Railroad  Company  put  out  a  new  stock  issue 
and  gave  to  its  stockholders  of  record  the  privilege  of 
buying  the  new  stock  at  par  in  any  amount  up  to  20  per 
cent  of  their  stockholdings.  Thus  if  a  man  had  100  shares 
ot   old  stock,   he  ^^as   given   an   opportunity   to  buy 
20  shares  of  the  new  stock  at  par.    The  average  price 
of  II  mois  Central  stock  during  the  six  months  follow- 
ing the  date  of  the  new  issue  was  l,56|/2,  thus  showing 
a  large  paper  profit  to  those  who  bought  the  new  stock 
As  this  stock  was  then  paying  an  8  per  cent  dividend, 
those  who  bought  and  held  it  for  investment  were  get- 
ting much  more  than  the  usual  market  return  on  their 
investment. 

A  great  many  stockholders,  howe-er,  do  not  care  to 
increase  their  capital  investment,  but  prefer  to  take  their 
profits  at  once.  In  such  a  case  thev  have  a  choice 
among  four  different  methods  of  securing  the  profits, 
as  follows: 

(a)   A  stockholder  may  buy  outright  the  proportion 


DISTRIBUTION  OF  THE  SURPLUS 


393 


of  new  stock  allotted  to  him  as  a  speculation,  and  a 
little  later  at  some  favorable  opportunity  may  sell  it. 

(b)  He  may  sell  "short"  after  the  issue  of  new  stock 
is  announced  and  deliver  when  he  gets  his  quota  of  new 

stock. 

(c)  Instead  of  selling  "short"  he  may  sell  outright 
an  amount  of  his  old  holdings  just  equal  to  the  amount 
of  new  stock  that  he  has  a  right  to  buy. 

(d)  He  may  sell  his  privilege  or  "right"  to  subscribe 
to  the  new  stock. 

It  will  be  well  to  compare  briefly  the  advantages  of 
these  four  methods. 

216.  Cashing  the  privilege.— The  subsequent  sale.— 
The  first-named  method  is  the  simplest,  but  not  gener- 
ally the  best.     The  chief  difficulty  is  that  the  stock- 
holder must  pay  cash  for  his  quota  of  the  new  stock; 
and  that  means  that  he  must  either  borrow  the  money 
or  must  lose  the  interest  on  some  of  his  own  funds. 
Frequently  the  subscriptions  to  the  new  stock  are  pay- 
ahle  in  installments.    There  may  be  a  period  of  several 
months  or  a  year  between  the  date  of  the  first  installment 
and  the  final  issue  of  the  stock.    For  many  stockholders 
it  may  prove  decidedly  inconvenient  either  to  use  their 
own  funt^s  or  to  borrow  money.    Another  disadvantage 
lies  in  the  well-known  fact  that  the  market  price  of  any 
stock  after  a  privileged  subscription  has  been  allotted 
to  it  almost  always  tends  downward.     One  reason  ob- 
viously is  that  the  new  issue  increases  by  so  much  the 
total  amount  of  stock  outstanding;  the  second  reason 
is  that  after  a  "right"  has  once  been  granted,  investors 
fi^nire  that  there  will  be  no  additional  rights  for  a 
number  of  years;  a  third  reason  is  that  the  chief  men 
interested  in  a  corporation  that  is  about  to  put  out  a 
neAv  issue  and  the  underwriters  of  a  new  issue  will  usu- 


i 


394 


CORPORATION  FINANCE 


ally  "bull"  the  previously  outstandinpr  stock  in  advance, 
in  order  to  create  u  good  denuuid  for  the  new  issue. 
Xow  a  stockholder  who  follows  the  first  of  the  four 
liiethods  and  does  not  sell  his  stock  until  after  he  has 
paid  for  and  i-cceived  it,  will  probably  sell  on  a  falling 
market  and  will  not  reap  as  much  profits  as  one  who 
follows  either  of  the  other  three  methods.  On  the  other 
hand,  it  must  be  said  for  this  first  method,  that  it  is  ab- 
solutely safe— a  statement  which  cannot  be  ;ii)plied  to 
the  method  next  to  be  considered." 

-'17.  Cashing  the  privilege.— "Short  selling. "—Tht 
mechanism  of  "sliort  selling"  has  already  been  treated 
in  Chapter  XVII.     In  the  case  immediately  before  us 
a  stockholder  who  had  the  rigjit  to  sid)scribe  to  twenty 
shares  of  a  new  issue  might  deposit  a  margin  of  10  to  15 
per  cent  with  his  broker  and  instruct  him  to  sell  short. 
The  broker  borrows  the  twenty  shares  in  order  to  make 
delivery  and  keeps  on  borrowing  until  the  stockholder 
is  able  to  get  his  twenty  new  shares  from  the  corporation 
and  turn  them  (ner  to  the  broker  to  repay  the  borrowed 
stock.    Under  this  arrangement  the  stockholder  will  be 
more  likely  tlian  under  the  first  method  to  get  the  top 
market  price,  because  he  will  sell  immediately  after  a 
"right"  is  announced— sometimes,  if  he  has  inside  in- 
formation,   even   before  such  announcement  is  made. 
This  method  further  makes  it  unnecessary  for  the  stock- 
holder to  borrow  any  money.    He  simply  turns  over  his 
rights  to  his  broker  who  uses,  in  order  to  pay  for  the 
new  stock,  the  money  that  he  has  received  from  the 
"short"  sale. 

All  this  sounds  very  easy  and  simple  and,  as  a  matter 
of  fact,  it  usually  works  out  all  right.  The  difficulty 
comes  in  the  fact  that  any  man  who  sells  sliort  runs  the 
risk  of  being  caught  in  a  bull  movement  of  that  stock 


DISTRIBUTION  OF  THE  SURPLUS 


395 


or  even  in  a  "corner."  *  The  reader  may  perhaps  sug- 
gest tliat  in  such  a  case  he  may  easily  make  delivery  from 
ills  old  stock  and  thus  obviate  any  serious  loss.  The 
answer  here,  however,  is  that  probably  he  has  sold  short 
the  amount  of  his  old  stock  as  well  as  of  his  quotp  of 
new  stock,  or  has  in  some  other  way  tied  up  the  old 
stock;  otherwise,  he  would  probably  follow  the  third, 
rather  than  the  second,  method.  Successful  corners  are 
not  very  common  in  Wall  Street  or  any  other  market. 
When  they  do  come,  however,  they  bring  disaster  and 
ruin  in  their  train. 

218.  Cashing  the  privilege.— Sale  of  old  stoch.~The 
third  method  is  not  open  to  either  of  the  objections  that 
have  been  specified.  The  stockholder  is  much  more 
hkely  to  get  the  best  market  price  t.'-an  under  the  first 
metliod ;  he  is  not  involved  in  the  dangers  that  attach  to 
the  second.  He  picks  his  o^n  time  to  sell  and  from  the 
proceeds  of  the  sale  has  funds  enough  to  buy  the  same 
amount  of  new  stock  with  large  profits  in  addition.  The 
sale  of  part  or  all  of  the  stockholder's  shares  will  not 
im])air  in  any  way  his  right  to  subscribe  to  the  new 
slocu,  inasmucii  as  this  right  is  always  granted  to  stock- 
holders of  record  on  a  given  day;  it  makes  no  difference 
whether  the  stockholder  of  record  increases  or  decreases 
his  lioldings  after  that  day.  The  only  fault  to  be  found 
with  this  method  is  that  it  is  not  practicable  for  all  stock- 
holders. A  great  many  of  them,  in  all  probability,  will 
have  their  holdings  posted  as  collateral  for  loans,  or  for 
some  other  reason  will  not  care  to  part  with  stock  even 
temporarily. 

219.  Cashing   the  privilege.— Sale  of  rights.— The 
fourth  method,  the  sale  of  "rights,"  is  the  next  best  plan 

iThe  menninf!:  of  the  term  "comer"  Is  explained  In  the  volume  on 
Investment  and  Specui^tion. 


396 


CORPORATION  FIX  ANTE 


ii 


I  ; 


I 

I    : 


■  ;■; 


i 

if: 


M'- 


Hii. 


ordinarily  and  is  much  used  by  those  who  do  not  care 
either  to  increase  their  holdings  or  to  decrease  them  even 
temporarily.     It  is  customary  when  any  of  the  large 
corporations   give   their   stockholders   a   "subscription 
privilege"  to  a  new  stock  issue,  to  send  out  to  each  holder 
of  record  a  formal  statement  of  the  number  of  new 
sliares  to  which  he  has  a  right  to  subscribe.    Such  doc- 
uments  may  be  endorsed  and  transferred  in  the  same 
way  as  stock  certificates  arA  are  bought  and  sold  on 
many  of  the  stock  exchanges  and  on  the  New  York 
Curb  Market.    These  documents  are  themselves  known 
as    rights,"  just  as  certificates  of  stock  are  loosely  called 
stock" 

As  .  t.    stated  in  Chapter  XVII,  there  are  confusing 
ditterencts  of  terminology  between  the  New  York  and 
some  of  the  othei-  stock  exchanges,  particularly  Phila- 
delphia     In  New  York  a  "right"  is  the  privilege  to 
subscribe  to  a  certain  amount,  usuallv  a  fractional  part 
of  a  share  of  new  stock.    A  stockholder,  therefore,  has 
as  many  "rights"  as  he  has  shares.    In  Philadelphia,  on 
the  other  hand,  a  "right"  means  the  privilege  of  buying 
one  of  the  new  shares  of  stock.    To  illustrate,  suppose 
that  the  Lehigli  Valley  Railroad  Company,  whose  se- 
curities are  listed  on  both  exchanges,  should  issue  new 
stock  to  old  stockholders  at  less  than  the  market  price 
and  should  give  the  subscription  privilege  at  the  rate  of 
one  new  share  to  every  five  old  shares.    In  that  case  the 
holder  of  five  shares  would  have  one  "right"  to  dispose 
of  on  the  Philadelphia  or  five  "rights"  on  the  New  York 
Exchange.    Of  course  the  Philadelphia  "right"  would 
be  worth  five  times  as  much  as  the  New  York  "right." 
The  difference  is  merely  in  terminology. 

Tt  may  be  thought  that  the  third  and  fourth  methods 
would  yield  practically  iie  same  returns,  but  this  is  an 


DISTRIBUTION  OF  THE  SURPLUS 


397 


error.  The  third  method  is  almost  always  more  prof- 
itable, the  reason  being  that  there  is  a  much  broader 
demand  for  stock  than  there  is  for  "rights"  to  subscribe 
to  stock.  As  was  explained  in  Chapter  XVII,  there  is  a 
large  body  of  purchasers  not  directly  concerned  with  the 
stock  market,  who  are  constantly  taking  the  standard 
stocks  out  of  that  market  and  holding  them  lor  perma- 
nent investment.  This  demand  does  not  e  \'ist  in  the  case 
of  "rights,"  because  few  people,  outside  vf  those  whose 
hiisJDess  it  is  to  kiiow  such  things,  understand  how  the 
value  of  a  "right"  is  figured  or  even  what  it  is.  It 
nonld  often  be  greatly  to  the  advantage  of  these  per- 
manent investors  if  they  did  buy  "rights"  instead  of 
stock.  As  the  matter  now  stands,  however,  almost  the 
only  buyers  are  stock  brokers  and  their  immediate  fol- 
lowers who  buy  as  a  quick  speculation  in  the  hope  of 
making  a  quick  profit.  As  they  are  willing  to  buy  only 
in  ease  they  think  they  are  getting  a  bargain,  it  follows 
[hv*  t'>?  price  of  rights  is  usually  less  than  it  should  be 
thetjretically. 

220.  Theoretical  value  of  a  right. — Let  us  see  how 
the  value  of  ft  right  should  in  theory  be  ascertained. 
The  reader  may  perhaps  have  jumped  at  the  conclusion 
that  the  vahie  would  be  the  difference  between  the 
market  price  of  the  old  stock  and  the  price  at  which  the 
new  stock  is  sold  to  stockholders.  This  is  incorrect, 
however,  because  it  fails  to  take  into  consideration  the 
change  in  the  value  of  each  share  brought  about  by  an 
increase  in  the  amotmt  of  stock  outstanding.  The  new 
stock,  it  must  be  remembered,  is  issued  at  less  than  the 
market  price,  and  does,  not,  therefore,  bring  to  the  com- 
pany's treasury  its  proportionate  amount  of  assets. 
For  this  reason  it  is  inevitable  that  the  market  price  of 


398 


CORPORATION'  FINANCE 


J-; 


m 


each  share  after  the  new  stc.ck  has  heen  iss,,eci  should  be 
iess  tlian  it  was  hefore.  ^ 

To  ilhistratc  these  ahstract  and  rather  vague  state- 
ments take  the  case  previously  cited,  that  of  the  Illinois 

stock  ^0  per  cent  and  gave  to  each  live  shares  of  old 
stock  the  i,r,v,  ege  of  suhscrihing  to  one  new  share  at 
par.    Ihe  nmrket  pnce  of  the  old  stock  at  the  tin.e  the 
rights  were  gianted  was  ahont  170,  giving  a  premium 
or  excess  ahove  par,  of  .$70  per  share^   xfw  tL4 "To' 
be  added  for  each  share  of  the  old  stock,  $20  in  assets 
becaus.  each  old  share  has  the  right  to  sub;cribe  to  00!: 
htth  of  a  iiew  share  at  par.    At  the  same  time  there  is  to 
be  added  $20  to  the  capital  stock  for  each  $100  preX 
ously  outstandin.^.     The  market  value  of  each  share, 
therefo^re,  after  the  new  stock  has  been  issued,  will  be 

IO0T20  ^^•"'^-  ^'  ^^'bich  in  theory  would  be  the 
market  price  of  each  share  after  the  new  stock  issue. 
As  a  matter  of  fact,  the  average  price  of  Illinois  Central 
shares  during  Ihe  six  months  following  August,1902. 
was  152  3-5.  The  va^.e  of  the  "right"  belonging  to 
each  share  of  old  stock  wo.dd,  of  course,  be  in  this  ease 
one-fifth  of  the  ditrerence  between  par  and  the  market 
pnce  of  each  share  of  new  stock,  or  1-5  of  58  1-3.  ap- 
proxmiately  11  2-3. 

The  f<,llowing  formula,  commonly  used  on  the  Xew 
1  ork  Stock  Kxchange,  gives  directly  (he  theoretical 
va  ue  of  u  nght.  Let  V  represent  Ihe  p,eun-un,  on  the 
oljl  shares  and  R  represent  the  percentage  of  increase. 
I  hen  the  value  of  a  right  will  he  fo,md  bv  the  formula 
I  X  1{ 
1  .fn      '^PPl.ving  this  formula  to  the  Illinois  Central 


mm 


'i^sv 


DISTIUBUTION  01   THE  SURPLUS 


399 


70  X  ^2 
.2 


example,    we   would    have    '    ^  '2  =  /^  =  11.66.     As 


+ 


14 
1.2 


has  been  stated  these  theoretical  prices  for  "rights"  are 
seldom  obtained  because  speculative  iiurchasers  of  rights 
are  not  willing  to  go  that  high,  ^loreover,  there  are 
some  assumpti  )ns  underlying  these  mathematical  form- 
ulae which  may  or  may  not  be  true.  It  is  assumed,  for 
instance,  that  the  stock  market  price  of  the  old  stock  is 
a  norma'  price  uninfluenced  by  speculative  factors.  It 
is  assumed,  also,  that  the  company's  use  of  the  funds 
which  come  to  it  from  the  sale  of  new  stock  will  be 
neither  more  nor  less  remunerative  than  the  use  of  the 
capital  funds  previously  in  its  possession.  It  is  assumed, 
moreover,  that  the  market  price  after  the  new  stock  has 
heen  issued  will  be  uninfluenced  by  speculative  factors. 
Tliere  is  a  risk  in  all  these  assumptions,  as  the  profes- 
sional stock  market  trader  well  knows,  and  he  is  there- 
fore unwilling  to  pay  the  full  theoretical  price  for  the 
rights. 

Summing  up,  then,  we  may  conclude  that  of  the  four 
methods  of  securing  profits  from  privileged  subscrip- 
tions, which  have  been  described,  the  third  method  is,  on 
the  whole,  likely  to  yield  the  largest  returns.  The  sec- 
ond method  comes  next  in  that  respect,  but  has  the  dis- 
advantage of  being  dangerous.  The  fourth  method 
comes  next,  and  the  first  method  is,  on  the  whole,  least 
desirable.  It  will  not  do  to  accept  these  conclusions  as 
heing  true  at  all  times  and  under  all  circumstances. 
They  are  merely  generalizations  based  on  experience. 

221.  Privilege  xuhsmpthns  a»  a  method  of  stock 
"K'ntering. — So  far  as  distribution  of  surplus  is  con- 
cerned, giving  "rights"  to  privileged  subscriptions  to 
new  issues  of  stock  produces  the  same  effect,  though 
not  to  an  equal  degree,  as  a  stock  dividend.    The  assets 


Hi 


tf 


!; 


III 


::'-\\ 

H 


ill;| 


fU 


WO 


CORPORATION  FINANCE 


f 


U 


I  s  ■. 


of  the  company  in  proportion  to  the  number  of  shares 
are  diminished,  and  the  stockholder  gets  the  benefit. 
If  the  old  rate  of  dividends  is  maintained  on  all  the  stock 
outstanding  after  the  new  issue,  each  stockholder  may  be 
truthfully  said  to  have  come  into  possession  of  some  of 
the  company's  surplus.  The  privileged  subscription  is 
a  device  for  increasing  capitalization  without  propor- 
tionately increasing  assets.  In  that  sense  it  is  "stock 
watering." 

The  meaning  of  the  terms  "stock  watering"  and 
"overcapitalization"  have  been  sufficiently  discussed  and 
need  not  be  given  further  attention.  It  is  enough  to 
reiterate  that  whatever  may  be  said  for  or  against  the 
practice  in  connection  with  public  serA'ice  corporations,  it 
is  in  private  corporations,  wlien  properly  used,  a  simple 
and  legitimate  means  of  making  a  corporation's  capital- 
ization correspond  to  its  earning  powers;  and  is  in  addi- 
tion, as  outlined  in  this  chapter,  a  legitmate  means  of 
transferring  to  the  stockholder  a  part  of  the  surplus 
which  his  company  has  created  for  him. 


^tf<lM 


CHAPTER  XXVI 

MANIPULATION  BY  CORPORATION  OFFICERS 

222.  Ought  we  to  study  manipulation? — So  far  we 
have  been  dealing  with  and  endeavoring  to  formulate 
the  principles  of  honest  and  efficient  corporate  manage- 
ment; the  rest  of  this  book  will  deal  with  dishonesty,  in- 
etficlency  and  failure.  Sometimes  any  study  of  rascal- 
ity is  condemned  offhand  on  the  ground  that  it  may 
siiffffest  swindling  practices  to  persons  who  otherwise 
would  not  have  thought  of  them.  Perhaps  there  is 
something  to  be  said  in  favor  of  this  view ;  if  any  readers 
of  this  volume  feel  themselves  morally  weak  it  may  be 
well  for  them  to  omit  the  next  three  chapters.  On  the 
other  side  of  the  argument,  we  may  say  that  a  thorough 
knowledge  of  fraudulent  methods  does  not  by  any  means 
encourage  fraud,  for  it  reveals  that  almost  all  such 
methods,  however  cunning  they  may  appear,  are  un- 
sound and  dangerous.  Furthermore — and  this  is  the 
important  point — honest  men  ought  certainly  to  acquire 
as  clear  an  insight  as  they  can  into  the  methods  of 
swindlers  in  order  that  they  may  be  on  their  guard  and 
may  protect  themselves  and  those  who  are  dependent 
upon  them. 

22.3.  The  corporate  form  favors  manipulation. — The 
corporation,  as  practically  every  biisiness  man  now  ap- 
preciates, is  for  most  concerns  the  most  convenient,  use- 
ful and  efficient  form  of  organization  that  has  yet  been 
ilcviscd.  Tt  is  likewise  true  that  tlie  corporation  so  far 
has  proA-ed  itself  a  most  efficient  form  in  the  hands  of 
r-vr_2fl  401 


402 


CORPORATION  FINANCE 


Ifl 


m 


i 


Jli 


Itlf 


rascals  for  transferring  other  people's  rightful  property 
into  their  own  pockets.  In  an  address  on  "Abuse  of 
Corporate  Privileges"  printed  in  the  American  Law 
licvictc  jSIr.  Seymour  D.  Thompson  has  described  from 
the  lawyer's  point  of  view  the  present  conditions.  He 
says: 

Our  corporate  life  is  honeycombed  with  corruption.  A  cor- 
poration is  formed ;  its  business  is  put  into  tlie  hands  of  cer- 
tain managers  holding  some  of  its  stock  and  expert  in  the  man- 
agement of  its  business.  Debts  are  created  and  the  managers 
become  the  creditors.  The  result  is  that  rings  arc  organized 
within  rings,  wheels  within  wheels,  combinations  within  com- 
binations. The  managers,  in  the  character  of  creditors,  seize 
upon  and  foreclose  the  property  of  the  corporation,  and  bv 
well-known  processes  scjueeze  the  other  stockholders  out  and  be- 
come themselves  pr()i)rietors  with  larger  lioldings  than  they  had 
before.  This  swotting  process,  dignified  by  the  name  of  fore- 
closing and  reorganizing,  has  come  to  be  a  regular  industry  in 
our  courts  of  justice.  Courts  of  justice  have  neither  the  time 
nor  the  means  to  take  upon  themselves  the  management  of  all 
the  corporations  in  the  country ;  and  therefore  the  outraged 
and  complaining  stockholders  are  told  that  they  cannot  come 
into  court  until  they  have  exhausted  all  the  remedies  within  the 
corporation. 

224.  Is  manipulation  a  necessary  evil? — Now  this  de- 
plorable condition,  which  is  one  of  the  cliief  evils  of  the 
-iVmerican  business  world,  is  not,  fortunately,  a  necessary 
evil.  We  may  well  doubt,  indeed,  whether  the  lawyers 
with  their  (juihbles  and  conservatism  will  do  much  to 
remedy  conditions.  IJut  wc  may  expect  much  from  the 
growing  interest  of  the  public  in  corporate  affairs.  Tlie 
t'vil  exists  chiefly  because  the  corporate  form  of  organ- 
ization is  still  a  thing  in  which  most  people  have  had  lit- 
tle experience  and  the  workings  of  which  they  do  not 


.MAMPULATION  BY  CORPORATION  OFFICERS      403 

clearly  understand.  The  true  remedy,  then,  for  the 
evils  of  corporate  nianipuldtion,  is  publicity  and  educa- 
tion. These  three  chapters  following,  which  constitute 
the  first  attempt,  so  far  as  the  author  knows,  to  classify 
{iiul  describe  the  methods  commonly  used  for  defrauding 
some  of  the  owners  of  a  corporation  for  the  benefit  of 
others,  will  fulfill  their  chief  purpose  if  they  have  some 
slight  influence  in  checking  this  evil. 

Perhaps  the  words  "fraud"  and  swindling"  in  the 
preceding  paragraphs  should  not  have  been  used;  they 
do  not  convey  exactly  the  conception  which  is  in  the 
author's  mind  in  writing  these  chapters.  We  are  not 
to  be  concerned  here  with  ordinary  clear  cases  of  fraud ; 
a  study  of  such  cases  belongs  to  law  rather  than  to 
finance.  IMoreover,  a  clear-cut  instance  of  fraud  is  not 
usually  a  very  dangerous  thing,  because  the  victim  may 
seek  and  obtain  redress  in  the  courts.  The  chief  danger 
comes  not  from  crude  and  obviously  illegal  larceny,  but 
from  acts  that  cannot  be  proven  fraudulent  and  that 
lieioiig  in  the  shadowy  borderland,  bounded  by  shrewd 
dealing  on  the  one  side  and  on  the  other  by  plain  swin- 
(IHiig.  Some  of  the  practices  to  be  described  are  allow- 
ahle,  although  most  of  them  are  discredited  under  the 
rules  of  the  business  game  as  those  rules  are  generally 
interpreted. 

'-'2.").  Scope  of  the  chapters  on  manipulation. — It 
should  be  made  plain  also  at  the  beginning  that  in  these 
chapters  not  much  will  be  said  about  "malefactors  of 
ureut  wealth"  or  al)out  large  "predatory  corporations,'* 
although  some  of  these  corporations  furnish  shining 
o\ain])les  which  cannot  be  overlooked.  We  shall  deal 
lather  with  everyday  small  business  corporations  and 
with  those  kinds  of  manipulation  that  may  be  found  in 
evcrv  section  of  the  country.     The  "sharks'*  of  Wall 


401 


CORPORATION  FINANCE 


Ifll 


';    t 


I 


'>': 
1   ; 


•  1. 


1 


J  5!: 


Street  do  not  oy  any  means  have  a  monopoly,  as  some 
of  the  cases  to  be  cited  will  show,  on  dubious  finance. 

As  a  basis  of  classification  we  will  take  up  methods 
of  manipulation  under  the  four  heads: 

(a)  Manipulation  by  officials. 

(b)  JNIanipulation  by  directors 

(c)  Manipulation  for  stockholders  as  a  body. 

(d)  Manipulation  for  controlling  stockholders. 

Of  course,  this  classification  is  not  exact.  We  shall 
find  constant  overlapping,  for  the  obvious  reason  that 
any  man  or  group  who  desire  to  manipulate  will  prob- 
ably try  to  make  their  control  as  complete  as  possible, 
and  will  work  through  stockholders'  meetings,  directors' 
meetings,  and  officers'  administration.  Nevertheless, 
this  classification  will  be  found  convenient  and  for  the 
present  purpose  sufficiently  accurate. 

226.  Eccorhitant  salaries.—  The  most  obvious  and 
common  method  by  which  a  corporation  official  may 
milk  a  corporation  of  its  profits  is  by  paying  himself  an 
exorbitant  salary.  This  is  a  practice  so  frequent  and 
so  easy  that  it  would  be  superfluous  to  cite  examples.  A 
corporation  official  cannot,  to  be  sure,  absolutely  fix  his 
own  salary,  for  that  power  is  reserved  to  the  directors. 
If  the  official,  however,  is  a  powerful  stockholder,  or  if 
two  or  three  officials  can  get  hold  of  a  majority  of  the 
stock,  or  if  an  official  can  bring  outside  pressure  to  bear 
upon  the  board  of  directors,  he  may  cause  a  salary  to 
be  allotted  to  him  far  in  excess  of  what  he  is  actually 
worth  to  the  company.  It  is  not  at  all  unusual  for 
minority  stockholders  in  small  corporations  to  be  de- 
prived of  profits  because  the  president,  or  other  official, 
who  owns  the  controlling  stock  raises  his  own  salary  as 
fast  as  profits  go  up.  Tl  would  be  very  difficult — prac- 
tically impossible — in  such  a  case  to  prove  fraud.    No 


MANirULATION  BY  CORPORATION  OFFICERS      405 


tijiirt  would  undertake  to  say  that  a  salary  was  fraudii- 
knl,  or  that  directors  were  acting  heyond  their  powers 
ill  a^ixrin^'  to  it,  unless  the  salary  were  heyond  all 
reason. 

'i'll.  Fraudulent  contracts. — Another  favorite  method 
of  manipulation  hy  officers  is  the  use,  or  rather  abuse, 
of  their  power  to  purchase  and  to  make  contracts 
on  behalf  of  the  corporation.  The  evil  of  purchasing  of- 
ficers being  in  league  with  the  firms  from  which  they 
buy  supplies  and  getting  a  rake-off  on  the  corporation's 
purciiases,  has  been  so  much  exploited  as  to  make  un- 
necessary any  further  illustration.  There  is  no  question 
but  tliat  something  of  the  kind  does  go  on  in  many  of 
the  larger  corporations.  Yet  the  purchasing  agent  is 
geneially  a  subordinate  official  whose  policy  is  closely 
scrutinized  by  his  superiors  and  who  is  subject  to  instant 
dismissal  if  any  strong  tendenoy  on  his  part  toward 
"flfrafting"  is  discovered.  His  delinquencies  are  not  so 
interesting  to  in  this  study  as  those  of  his  superiors. 
Let  us  examine  briefly  a  few  instances  in  which  high  cor- 
porate officials  have  misused  their  power  to  bind  the 
corporation. 

In  the  Illinois  courts  some  years  ago  suit  was  brought 
by  II.  P.  Killjoy,  a  stockholder,  against  the  Mandarin 
Brewing  Association.  He  alleged,  and  seems  to  have 
proved  to  the  satisfaction  of  the  court,  that  in  1896 
three  brothers  purchased  a  majority  of  the  stock  and 
ol)tained  control  of  this  brewing  corporation  They 
(Iccted  themselves  to  the  directorate  and  to  most  of  the 
c(»rj)oration  offices  One  of  the  brothers  owned  a  piece 
.of  real  estate  which  the  corporation  purchased  at  an 
a?!i(t!!nt  nllegcd  to  have  bern  far  in  excess  of  its  true 
vahie.  The  brothers,  as  directors,  paid  themselves  large 
salaries  as  officers  and  no  dividends  were  forthcoming 


H. 


w^W 


40G 


CORPORATION  FINANCE 


r     s 


f      T 


I      i 


4 

ill 


lip 

II 

N| 

;  H 

r  i     If- 


to  the  stockholders.  The  stockholders  were  kept  in 
ignorance  of  the  purchase  of  the  real  estate  and  of  the 
size  of  the  salaries.  Although  the  court  was  so  far 
convinced  of  the  truth  of  these  allegations  that  a  re- 
ceiver was  appointed  for  the  company,  no  criminal  or 
civil  action  was  taken  against  the  three  brothers. 

The  facts  cited  in  a  recent  case  in  the  Massachusetts 
courts  are  of  interest  in  this  connection.  Samuelson, 
defendant  in  the  case,  was  treasurer  of  the  Easton 
Ferry  Company.  He  sold  bonds  of  the  company  and 
neglected  to  account  for  them.  He  charged  the  com- 
pany for  bank  discounts  larger  than  the  bank  charged, 
claiming  that  this  extra  discount  was  for  his  own  per- 
sonal indorsement,  which  appeared  on  the  notes.  He 
purchased  coal  in  his  own  name  at  a  low  price  and, 
as  treasurer,  bought  the  same  coal  for  the  company 
from  himself  at  a  high  price.  In  this  case  the  court 
ruled  that  Samuelson  sliould  be  charged  with  the  market 
value  of  the  bonds  that  he  had  sold  and  should  refund 
the  difference  between  the  market  price  of  the  coal  and 
the  price  at  which  he  had  purchased  it  from  himself 
for  the  company.  Here  again  there  was  no  hint  of 
criminal  liability  or  punishment. 

Take  another  case,  this  time  from  the  New  York 
courts.  Two  officers  of  a  paper  company  obtained  an 
option  to  purcliase  a  manufacturing  plant  for  $75,000. 
The  same  plant  was  sold  to  the  corporation,  of  which 
one  of  the  defendants  was  president,  for  $100,000. 
The  deed  was  taken  directly  from  the  owner  of  the 
plant  to  the  corporation  reciting  a  consideration  of  $1. 
The  majority  of  the  stockholders  bad  no  knowledge  of^ 
the  option  price  of  ?|^7;3,000  until  later.  On  learning 
the  facts  they  elected  new  officers  who,  on  behalf  of  the 
company,  brought  suit  against  the  defendants  for  the 


MANirULATION  BY  CORPORATION  OFFICERS      407 

(litl'trcnce  between  the  true  purchase  price  and  the  price 
charged  to  the  cori)oration.  The  suit  was  unsuccess- 
ful. " 

As  this  is  not  a  legal  treatise,  a  discussion  of  the  exact 
legal  reasons  for  the  decisions  of  the  court  in  each  of  the 
three  cases  cited  is  not  necessary  here.  The  important 
feature  common  to  the  three  cases  and  common  to 
practically  all  similar  cases  is  that  in  the  present  state 
of  the  law  an  official  may  make  contracts  and  purchases 
directly  advantageous  to  himself  and  disadvantageous 
to  the  corporation  without  fear  of  punishment — pro- 
vided, of  course,  that  he  and  his  lawyers  make  no  legal 
blunders.  Assuming  that  he  avoids  this  pitfall,  the 
worst  that  can  happen  to  him  through  the  operation  of 
the  law  is  a  restitution  of  his  ill-gotten  gains,  which  is, 
of  course,  no  punishment  at  all.  His  true  punishment 
conies  simply  in  the  fact  that  sooner  or  later  his  dis- 
honesty will  be  discovered  and  his  reputation  among 
honorable  business  men  vill  be  indelibly  smirched. 

228.  New  companies  for  profitable  business. — A  third 
method  by  which  corporation  officials  often  transfer 
an  undue  portion  of  corporate  profits  to  themselves  is 
by  the  formation  of  new  companies  for  profitable  busi- 
ness. Every  corporation,  whether  it  be  railroad,  in- 
dustrial, trading  or  financial,  will  find  some  features 
of  its  operations  more  profitable  than  others.  The 
ordinary  stockholder  may  not  know  anything  about 
the  actual  operation  of  the  business  or  about  the  oppor- 
tunities for  large  profits;  obviously  the  officers  who  do 
understand  the  situation  are  under  a  strong  temptation 
to  use  their  knowledge  for  their  own,  instead  cf  for  the 
corporation's,  benefit. 

Tlie  writer,  for  instance,  knows  of  a  company  of  con- 
siderable size,  which  is  in  the  business  of  buying  and  sell- 


408 


roiiroiiATiox  rix a\(  i : 


ing  domestic  rugs  and  carpets.  The  concern  began  to 
deal  in  a  small  way  in  oriental  rugs  and  Smith  and  Jones, 
the  president  and  officenianager,rcs])cctively,  discovered 
at  once  that  in  their  town  this  business  was  extra- 
ordinarily profitable.  Instead  of  taking  hold  of  the 
business  and  developing  it  for  the  established  corpo- 
ration of  which  they  were  officers,  Jones  resigned  his 
position,  organized  a  new  company,  in  which  Smith 
was  secretly  a  large  stockliolder,  and  quickly  secured 
all  the  oriental  rug  trade  of  their  city  for  the  new  cor- 
poration. The  stockholders  of  the  first  corporation 
retain  Smith  as  their  president  to  this  day  and  regard 
him  highly  for  his  business  ability.  At  the  same  time, 
Smith  is  growing  rich  from  the  profits  of  the  new  cor- 
poration. The  stockholders,  even  if  they  know  all  the 
facts,  would  not  be  justified  in  saying  that  they  had  been 
defrauded.  All  that  they  have  lost,  in  fact,  is  an  op- 
portunity. The  ethics  of  the  proposition  is  too  big  a 
question  to  be  here  discussed.  Whether  the  action  of  the 
officials  in  this  case  be  regarded  as  right  or  wrong,  it 
is  certainly  true  that  its  eflPect  was  to  transfer  possible 
profits  from  the  corporation  to  the  officers. 

Take  another  instance,  which  has  been  related  to  the 
writer  by  a  public  accountant.  The  Automatic  Dooi 
Fastening  Company  is  a  corporation  with  a  large  cap- 
italization. It  controls  a  patent  device  that  can  be 
cheaply  manufactured  and  readily  sold  at  a  good  price 
The  officers  easily  sold  the  stock  to  a  number  of  smal 
investors  who  were  impressed  w^ith  the  high  value  ol 
the  patent  and  the  large  profits  which  would  certainlj 
be  forthcoming  as  soon  as  it  was  put  on  the  market 
The  corporation  secured  the  necessary  amount  of  capita 
funds,  and  manufactured  the  device;  at  this  point  th( 
stockholders    learned    that    a    subsidiary   corporation 


MANIPULATION  BY  CORPORATION  OFFICERS      409 

owned  l)y  the  officers,  had  been  formed  in  each  section 
ot  the  country  where  sales  were  expected  to  be  large  and 
that  every  subsidiary  corporation  had  a  hard  and  fast 
eoiitract  with  the  parent  company  by  which  the  sub- 
sidiary company  got  the  device  at  a  price  that  barely 
covered  the  cost  of  manufacture  and  was  given  exclusive 
selliiiK  rights  in  its  own  section.  Practically  all  the 
j)i(){its  evidently  were  thereby  transferred  from  the  cor- 
poration to  the  subsidiary  companies.  However  the  des- 
patch lines  have  now  been  taken  over  by  the  railroad 
companies,  so  that  there  is  no  possibility  of  manipula- 
tion in  the  future. 

Tliere  is  nothing  new  in  such  an  arrangement. 
Tliirty-five  years  ago  when  the  numerous  short-distance 
raihoads  of  the  United  States  were  first  being  consoli- 
dated into  systems,  railroad  officials  discovered  that  the 
most  profitable  traffic  was  that  which  moved  over  long 
distances.  It  was  not  long  after  this  discovery  before 
twenty-five  or  thirty  "despatch  lines"  and  "fast  freight 
lines"  were  in  existence,  each  of  which  handled  the 
tlirough  long-distance  traffic  over  two  or  more  railroads 
under  contracts  by  which  much  the  greater  portion  of 
tlie  large  profits  went  to  the  despatch  line  companies. 
It  is  almost  needless  to  add  that  the  chief  stockholders 
of  these  new  companies  were  railroad  officials. 

Tlie  same  principle  was  applied  by  Commodore 
Vanderbilt  when  the  New  York  Central  System  was 
t'oiined  by  holding  in  his  own  hands  the  stock  of  com- 
l)anies  which  owned  the  important  terminals  of  the  rail- 
road. These  terminals  were  then  leased  to  the  New 
York  Central  on  terms  that  were  not  generally  exorbi- 
tant, but  that  nevertheless  yielded  a  large  return  to  the 
Commodore.  Although  the  Vanderbilt  family  for  many 
years  have  not  held  a  majority  or  anything  like  a 


41U 


C01ll»0UATI0\  l-IX.VNCE 


1*^ 


majority  of  the  Xew  York  Central  stock,  yet  they  have 
been  able  to  dominate  the  niana^cnient  of  that  road  and 
to  secure  for  themselves  lar^^e  profits  through  their 
ownership  of  these  terminal  companies. 

229.  Mia  use  of  inside  information.  —  The  fourth 
method  of  milking-  a  corporation  for  the  benefit  of  its 
officers  is  by  making  use  of  "inside"  information.  This 
is,  on  the  whole,  the  safest  and  least  disreputable  method. 
Indeed  the  line  between  the  proper  and  improper  use 
of  the  information  that  necessarily  comes  into  the 
officers'  possession  is  so  indistinct  that  no  one  has 
yet  been  able  to  trace  it.  We  are  all  agreed,  no  doubt, 
that  it  is  quite  improper  for  the  president  of  a  corpora- 
tion  to  make  a  business  of  speculating  in  the  stock  of 
his  company,  specially  if  he  "sells  short"  and  thereby 
puts  himself  under  temptatitm  to  mismanage  the  com- 
pany. On  the  other  hantl,  probably  few  people  would 
raise  any  objection  to  an  officer's  investing  m  some 
shares  of  his  company's  stock,  if  he  has  good  reason  to 
believe  that  the  stock  is  selling  below  its  true  value; 
nor  does  there  seem  to  l)e  any  valid  objection  to  his 
selling  this  same  slock,  if  later  he  discovers  that  spec- 
illative  forces  have  raised  it  far  above  its  true  value. 
Now  just  where  shall  the  line  between  what  is  proper 
and  improper  in  this  regard  be  drawn?  Xo  one  can 
say.  It  is  as  shadowy  as  the  line  between  speculative 
and  investment  buying 

Whatever  (loul)t  tlurc  may  J)c  as  to  whether  the  use 
of  inside  information  by  a  corporation  officer  to  guide 
his  buying  and  selling  of  stock  is  improper  or  not,  there 
can  certainly  be  no  (piestion  but  that  the  use  of  such  in- 
formation l)y  an  officer  in  order  to  enrich  himself 
directly  at  the  expense  of  the  corporation  is  wholly  un- 


MAMI'lLATION   BV   COUrOUATION  OFFICERS      411 


justiHiible.     The  three  cases  cited  below  are  fair  ex- 
amples (tf  what  is  sometimes  done: 

(a)  An  officer  of  an  oil  refining  company  in  Pennsyl- 
vania, who  liad  no  authority  to  sell  stock  for  the  cor- 
poiatioit  received  a  buying  order  addressed  to  him- 
self as  an  official  of  the  corporation  for  5,000  shares 
at  '20  cents  a  share.  He  filled  the  order  by  transferring 
j.OOO  shares  from  himself  to  the  purchaser  and  then 
took  for  himself  5,000  shares  of  treasury  stock  at  the 
special  price  of  2  cents  a  share.  In  this  case,  the  facts 
I>tiii<,'  fully  proved,  the  court  ordered  a  refund  of  the 
difference  between  the  two  prices  to  the  corporation. 

(b)  The  XYZ  Manufacturing  Company,  with  capi- 
tal stock  of  $500,000,  one-half  paid  in,  went  into  re- 
ceivers' hands.  The  company  had  notes  for  $20,000  out- 
standing, bearing  10  per  cent  interest  and  secured  by 
a  mortgage  on  its  property.  The  president,  knowing 
the  condition  of  the  company,  just  before  the  failure, 
steined  the  notes  in  exchange  for  $30,000  face  value 
of  his  stock  in  the  company.  Ten  thousand  dollars 
»vas  paid  on  the  notes  when  they  fell  due,  but  the 
other  stockholders  objected  to  paying  the  remainder. 
The  president  transferred  his  claim  for  the  remaining 
i^'lO.OOO  to  an  outsider  and  the  court  enforced  payment 
of  the  claim. 

(c)  Robinson,  the  treasurer  of  a  railroad  company, 
whi  '  was  in  poor  condition,  bought  up  outstanding 
notes  of  the  company  at  a  large  discount  with  his  own 
money  and  as  treasurer  saw  to  it  that  the  notes  were 
paid  when  due  at  their  full  face  value.  The  court 
lii'ld  that  the  treasurer  had  done  nothing  illegal.  He 
was  nt  liberty  to  buy  the  notes  for  himself,  as  he  was 
!!nd<T  no  ()!)ligaf:ion  to  buy  them  for  the  road.  He  could 
ii'tet  them  when  due  with  the  road's  money,  as  that 


m 


412 


CORPORATION  FINANCE 


money  was  there  to  pay  any  or  all  of  the  road's  debts  and 
not  any  special  debt. 

The  striking  feature  of  these  three  cases,  as  in  several 
of  the  other  cases  cited,  is  that  although  the  officials 
were  obviously  unfaithful  to  their  trust  and  were  not 
acting  in  good  faith  as  agents  for  the  corporation,  they 
were  nevertheless  able  to  escape  legal  punishment. 

230.  /«  manipulation  by  officers  common? — The  four 
methods  that  have  been  given  and  illustrated,  by  which 
corporations  are  frequently  deprived  of  part  of  their 
just  profits  by  their  own  officers  are: 

(a)  Exorbitant  salaries. 

(b)  Collusion  or  fraud  in  marketing,  purchases  and 
contracts. 

(c)  Formation  of  new  companies  for  especially  pro- 
fitable business. 

(d)  JMisuse  of  confidential  Information  which  comes 
to  officers  by  virtue  of  their  position. 

It  would  certainly  be  a  gross  exaggeration  to  say  that 
all  or  a  majority  of  the  corporation  officers  of  the  United 
States  are  guilty  of  any  of  these  practices.  On  the  con- 
trary, it  is  probably  true  that  their  dealings  with  or 
for  the  corporation  which  they  serve  are  in  most  cases 
absolutely  honorable.  Yet  it  must  be  regretfully  ad- 
mitted that  these  four  methods  of  milking  a  corporation 
are  only  too  well-kno>vn  and  too  skillfully  practiced.  As 
an  accountant  of  wide  experience  says,  in  speaking  of 
corporate  manipulation  by  officers,  "That  this  is  con- 
stantly being  done  is  obvious  from  the  fact  that  so  many 
men,  drawing  salaries  with  large  corporations,  of 
$10,000  to  $15,000  a  year,  become  millionuires  in  a  very 
short  period.  It  is  a  mere  matter  of  arithmetic  to 
demonstrate  that  this  is  not  done  out  of  the  money  that 
they  save." 


jIAMI'LLATION  BY  CORPORATION  OFFICERS      413 

■>3i.  Canada  fairly  free  from  manipulation.— Com- 
parativtly  little  is  heard  in  Canada  respecting  manipula- 
tion by  corporation  directors.  The  chief  complaint  along 
that  line  seems  to  have  been  regarding  the  profits  made 
bv  promoters  of  new  companies  and  of  industrial  con- 
solidations, which  naturally  has  included  directors.  The 
investor,  in  future,  will  undoubtedly  keep  a  sharp  watch 
upon  this  opportunity  for  abuse. 

The  tendency  in  the  Dominion  is  for  corporations  to 
employ  reputable  chartered  accountants  and  appraisal 
eonipanies  to  examine  and  report  upon  their  financial 
position  for  the  benefit  of  shareholders  and  prospective 
investors.    This  is  a  gratifying  development. 

With  regard  to  dividend  and  other  official  announce- 
ments of  corporations,  Canada  has  been  notably  free 
from  the  premature  divulgence  of  information.  The 
secrecy  with  which  such  announcements  as  that  of  the 
Canadian  Pacific  Railway,  for  instance,  are  guarded,  is 
noteworthy.  Not  a  whisper  is  bet  d  in  financial  circles 
until  the  statements  are  issued  from  the  directors*  meet- 
infj  or  the  office  of  the  president. 

Few  cases  have  come  to  light  wherein  Canadian  di- 
rectors have  benefited  in  stock  operations  by  the  receipt 
of  "inside"  information. 


CHAPTER  XXVII 


%^ 


1W*  .      ;  31 


MANIPULATION  BY  DIRECTORS 

232.  Usual  methods.-As  has  already  been  stated,  it 
IS  difficult  to  draw  the  line  between  manipulation  bv 
officers  and  manipulation  by  directors,  for  in  most  case's 
more  or  less  collusion  between  the  two  is  essential  to  the 
success  of  any  of  their  fraudulent  schemes.  It  is 
possible,  however,  to  draw  a  distinction  between  those 
lorms  of  manipulation  which  are  primarily  intended  for 
the  benefit  of  officers  and  those  forms  which  are 
primarily  for  the  benefit  of  directors;  with  the  latter 
class  of  manipulative  methods  we  have  now  to  deal 

The  method  that  was  given  the  first  place  in  our  con- 
sideration of  manipulation  by  officers,  namely,  exorbi- 
tant  salaries,  is  not  worth  attention  here.     Directors 
to  be  sure,  are  frequently  allowed  fees  for  attending 
meetings,  and  sometimes  these  fees  seem  to  be  somewhat 
excessive.    They  are  frequently  prescribed,  however,  in 
the  by-laws,  in  which  case,  of  course,  the  stockholders 
as  a  body  would  have  no  ground  for  complaint  against 
the  directors  as  a  body.    In  any  case,  the  fees  are  not 
large  enough  to  make  it  worth  while  for  the  directors 
to  attempt  to  defraud  the  stockholders  and  enrich  them- 
selves    by    this    particular    method.      Without    much 
question  the  courts  would  set  aside  <iirectors'  fees  for 
attending  meetings  much  higher  than  $10  to  $25  for 
each  meeting  and  would  look  with  suspicion  on  an 
especially  large  number  of  meetings. 

414 


MANIPULATION  BY  DIRECTORS 


415 


Eliminating  this  possible  method  of  manipulation, 
then,  as  of  small  consequence,  we  may  set  down  four 
important  and  not  uncommon  means  of  transferring 
an  undue  proportion  of  a  company's  assets  and  profits 
to  the  pockets  of  its  directors.    These  four  methods  are: 

(a)   Fraudulent  purchases  and  contracts. 

(h)  Formation  of  new  companies  for  especially 
profitable  business. 

(c)  Deceiving  the  body  of  stockholders  by  means  of 
juggled  accounts. 

( (I)  Forcing  the  corporation  unnecessarily  into  bank- 
ruptcy or  into  receivers'  hands. 

The  reader  will  observe  that  the  first  two  methods 
liavc  been  discussed  in  the  preceding  chapter.  There 
arc,  !(  v,(  vcr,  some  vacations  that  should  be  mentioned 
ht'twcen  Ih.c  application  of  these  methods  by  officers  and 
by  directors. 

233.  Fraudulent  contracts. — The  number  of  cases  of 
fraudulent  purchases  and  contracts  by  directors  that 
have  been  brought  before  the  courts  are  so  numerous 
that  it  is  difficult  to  make  a  selection.  The  following 
instances  are  typical: 

(a)  In  an  Alabama  case  the  facts  brought  out  were 
as  follows:  The  promoters  of  a  large  electric  manu- 
facturing company  obtained  as  a  profit  in  its  formation 
approximately  $2,000,000  of  stock  and  were  thereby 
able  to  exercise  considerable  influence  on  the  board  of 
directors.  The  directors,  in  spite  of  the  demands  of 
scxcral  stockholders,  neglected  to  seek  to  recover  from 
the  promoters  any  portion  of  their  excessive  profit.  Suit 
was  brought  by  n  stockholder  to  compel  the  directors 
to  act  and  they  replied  that  they  deemed  the  proposed 
a  I  tempt  to  recover  inexpedient.  It  is  intimated  in  the 
court's  decision  that  they  were  improperly  influenced 


416 


CORPORATION  FINANCE 


by  the  promoters  and  the  court  ordered  them  to  makf. 
the  attempt. 

(b)   Three  directors  of  a  corporation  formed  to  buUd 
a  summer  resort  hotel  caused  the  corporation  to  pur- 
chase the  land  on  which  the  hotel  was  to  be  located  from 
themselves  at  a  200  per  cent  profit  to  themselves.    The 
land   was    purchased    subject    to   a   heavy   mortgage 
When  only  $2.5,000  had  been  subscribed  toward  the 
$90,000  required  to  erect  the  hotel,  the  directors  made 
a  contract  to  start  construction  of  the  building.    Their 
object  in  so  doing  was  to  enhance  the  value  of  other 
land  in  that  vicinity  which  they  owned.     The  corpora- 
tion became  insolvent  and  the  directors,  on  foreclosing 
then-  mortgage  on  the  land,  virtually  became  the  owners 
of  the  land  and  of  as  much  of  the  hotel  building  as  had 
been  erected.    The  court  in  this  case  held  that  the  direc- 
tors were  liable  to  the  stockholders  for  the  depreciation 
m  the  market  value  of  the  stock. 

(c)  Two  of  three  directors  of  a  South  Dakoifa 
corporation,  for  the  purpose  of  securing  control  of  the 
corporation  for  themselves,  caused  the  issue  and  im- 
mediate sale  to  one  of  their  friends  of  a  large  amount 
of  new  stock  sufficient  to  give  the  two  directors  and 
their  friend  together  a  majority.  The  court  held  that 
as  the  friend  knew  all  the  facts,  the  sale  of  the  stock 
conferred  no  rights  upon  the  purchaser.  It  may  be 
inferred  from  this  decision  that  if  the  purchaser  had 
been  an  innocent  party,  the  transaction  would  have 
been  valid. 

(d)  In  a  somewhat  similar  instance  in  Xew  York 
a  full  lioard  of  directors  authorized  the  issue  of  sixty- 
seven  shares  of  stock  to  increase  its  capital.  The  presi- 
dent of  the  company  reported  at  a  subsequent  meeting 
that  he  had  received  no  subscriptions,  and  four  of  the 


MANIPULATION  BY  DIRECTORS 


417 


seven  directors  thereupon  took  the  stock  without  knowl- 
edge of  the  holder  of  the  majority  of  stock  previously 
issued,  who  was  also  a  director.  In  this  case  the  court 
allowed  the  purchasers  to  hold  and  vote  the  stock,  but 
enjoined  them  from  using  it  to  the  injury  of  the  pre- 
vious majority  holder. 

(e)  A  railroad  company  was  organized  in  Minnesota 
to  build  a  local  road  in  that  state.     Capital  stock  of 
$2,000,000  and  bonds  to  the  extent  of  $1,500,00  were 
authorized.    A  director  and  owner  of  a  majority  of  the 
outstanding  shares  drew  up  a  contract  with  the  XYZ 
Construction  Company  under  which  the  company  was 
to  build  the  road  and  receive  331  shares  of  its  capital 
stoek  together  with  first  mortgage  bonds  to  the  amount 
of  .$20,000  per  mile.    The  XYZ  Construction  Company 
then  made  a  contract  on  its  own  account  with  the 
firm  of  A  &  B,  under  which  the  firm  was  to  pay  $5,446 
for  each  $20,000  block  of  bonds  and  in  addition  was  to 
furnish  the  material  necessary  to  build  the  road.     The 
director  above  referred  to  was  interested  with  A  &  B 
and  was  to  receive  for  himself  an  agreed  share  of  the 
railroad  bonds.     The  actual  cost  of  construction  was 
to  be  about  $14,000  a  mile.    The  contract  came  before 
the  board  of  directors  and  two  directors,  whom  we  shall 
call  Smith  and  Jones,  voted  for  the  contract  with  the 
understanding  that  they  also  were  to  become  interested 
with  A  &  B  and  to  receive  a  portion  of  the  profits. 
Vfterwards  they  offered  to  contribute  one-fourth  of  the 
cash    required    for   actual   construction   of   the   road 
in  order   to  become   partners  with   A   &   B.     Their 
offer  was  refused.     They  then  brougbt  suit,  exposed 
tlu  whole  transaction  and  asked  to  have  the  contracts 
(leelnred  void  for  fraud.     The  court  held  that  there 
was  no  fraud  on  the  face  of  the  transaction  but  that 

r— VI_27 


418 


CORPORATION  FINANCE 


fraud  could  plainly  be  inferred,  inasmuch  as  the  cor- 
poration was  made  to  pay  more  than  was  necessary  for 
construction.  They  held,  however,  that  the  two  direc- 
tors, Smith  and  Jones,  having  knowledge  of  the  trans- 
action, did  not  come  into  court  with  "clean  hands"  and 
could  not  cry  fraud  because  they  lost  what  they  had 
attempted  to  gain.  The  contract,  therefore,  was  not 
set  aside. 

234.  Attitude^  of  the  courts. — These  illustrations, 
taken  almost  at  random,  indicate  what  opportunities  for 
fraudulent  manipulation  are  open  to  corporate  directors 
and  how  slight  is  the  danger  of  legal  punishment.  As 
may  be  observed  over  and  over  again,  the  courts  assume 
that  a  corporation  is  honestly  managed  in  accordance 
with  the  wishes  of  the  stockholders  unless  the  contrary 
is  absolutely  proved.  Stockholders  who  object  to  the 
contracts  and  purchases  made  by  their  directors  are 
apt  to  be  told  that  their  true  remedy  is  to  elect  a  new 
board. 

Obviously  this  principle  of  the  law,  however  far  from 
applicable  it  may  be  in  particular  cases,  works  out,  on 
the  whole,  for  the  good  of  the  greatest  number.  Most 
corporations  are  honestly  managed.  Directors  are 
rightly  believed  generally  to  have  a  far  more  extensive 
knowledge  of  the  affairs  of  the  corporation  and  of  the 
contracts  and  purchases  that  should  be  made  than  the 
body  of  stockholders  have.  The  courts,  therefore, 
ordinarily  do  not  desire  to  set  aside  contracts  made  by 
the  directors  or  even  by  investigation  to  cast  doubt  upon 
those  contracts.  The  attitude  of  the  courts,  it  must  be 
admitted,  is  correct.  On  the  ot?ier  hand,  as  the  in- 
stances given  above  plainly  indicate,  it  is  also  true 
that  this  attitude  gives  directors  almost  unlimited  op- 
portunities  for   fraudulent   manipulation.     The  only 


iMANIPULATION  BY  DIRECTORS 


419 


practicable  remedy  in  the  long  run  is  for  the  stockholders 
to  be  exceedingly  careful  to  elect  men  of  proved  pro- 
l)ity  to  their  directorate. 

'2ti5.  Ncvc  companies  for  profitable  business. — The 
second  method  of  manipulation  by  directors  that  has 
been  named  is  the  formation  of  new  companies  for 
profitable  business.  A  few  typical  illustrations  will  best 
explain  the  working  of  this  method. 

(a)  The  directors  of  a  Xew  York  building  and  loan 
association,  the  charter  of  which  required  the  funds  to 
be  invested  in  first  mortgages,  nevertheless  bought  some 
second  mortgages.  The  association  became  insolvent 
and  receivers  were  appointed.  Some  of  the  directors 
then  organized  a  realty  company  which  took  from  the 
receivers  the  land  and  buildings  owned  by  the  associa- 
tion at  50  cents  on  the  dollar  and  made  part  payment 
witli  additional  second  mortgages.  The  directors  thus 
secnred  for  themselves  at  small  cost  most  of  the  valuable 
assets  of  the  association.  The  court  discharged  the  re- 
ceiver and  appointed  another  receiver  to  conserve  the 
remaining  assets. 

( h )  The  Strong  Lumber  Company  and  the  Hoffman 
Manufacturing  Company  elected  three  men,  constJ- 
tuting  a  majority  of  both  boards,  directors  of  both  com- 
panies. The  Hoffman  Manufacturing  Company,  which 
had  the  better  credit,  accepted  time  drafts  drawn  upon 
it  by  the  Strong  Lumber  Company,  although  no 
consideration  had  been  given.  To  secure  themselves 
from  personal  liability  the  three  men  as  directors  of  the 
Strong  Company  placed  a  mortgage  on  the  property 
of  that  company  and  issued  bonds  which  were  turned 
over  to  the  Hoffman  Company.  When  the  facts  were 
presented,  the  court  entered  a  decree  setting  aside  the 
mortgage. 


I 
I 


420 


CORPORATION  FINANCE 


(c)    The  directors  of  a  railroad  company  in  Nevada 

were  members  of  a  syndicate  which  intended  to  build 

a  connecting  road.     The  road  was  built  and  paid  for 

by  the  syndicate  and  was  mortgaged  heavily      The 

syndicate  received  all  the  bonds  and  stock  and  then 

transferred  51  per  cent  of  the  stock  to  the  railroad  com- 

pany,  of  which  they  were  directors,  in  consideration  of 

this  company's  guaranteeing  the  bonds.    The  guarantee 

of  the  bonds  allowed  the  syndicate  to  sell  them  at 

a  good  price.    The  court  held  that  allegations  of  fraud 

were  not  sustained  and  that  the  whole  transaction  was 

legitimate. 

In  the  last  two  cases  the  profit  to  the  directors  evi- 
dently came  in  the  form  of  increased  credit  for  companies 
m  which  they  were  interested.     It  seems  clear  in  both 
cases  that  there  was  no  corresponding  advantage  to  the 
corporation;  otherwise  the  corporation  in  each  case 
would  have  made  the  arrangement  on  its  own  account 
The  reader  will  observe,  no  doubt,  that  directors  have 
opportunities  of  the  same  kind  as  those  which  fall  to 
officers,  when  it  is  discovered  that  some  particular  feat- 
ure of  a  company's  business  is  especially  profits,  e. 
Either  the  directors  or  the  officers,  or  both  together,  may 
organize  a  new  company  of  their  own  to  handle  that 
business  and  thus  may  divert  profits  to  themselves. 

236.  Juggling  accounts.— ^he  third  means  open  to 
directors,  who  wish  to  manipulate  corporate  affairs  for 
their  own  interests,  is  to  tamper  with  the  corporation's 
books  and  thus  give  the  stockholders  a  wrong  impression 
as  to  the  company's  condition.  The  methods  that  mav 
be  used  to  accomplish  this  object  are  so  numerous  and 
so  complicated  that  it  would  he  impracticable  to  enumer- 
ate all  of  them  here.  Indeed,  this  section  of  our  subject 
belongs  to  accounting  rather  than  to  finance.    A  few 


MAxNirULATION  BY  DIRECTORS 


421 


typical  instances,  however,  which  have  been  supplied 
hy  some  of  tlie  most  experienced  and  best  known  public 
accountants  in  thv  T/nited  States  to  the  writer,  may  be 
eniinierated.  The  reader  will  find  further  light  on  this 
iiiiportant  subject  in  the  volume  on  Auditing. 

( a )   The  directors  of  a  holding  company,  which  owned 
tlie  entire  stock  of  four  separate  manufacturing  com- 
panies, desired  to  present  a  favorable  report  of  the 
\ear's  operations  to  their  stockholders.     In  order  to 
do  so  they  took  into  account  dividends  paid  by  three 
of  the  companies  and  ignored  altogether  a  very  heavy 
loss  incurred  by  the  fourth  company.    Their  excuse  for 
so  doing— which  excuse,  however,  carries  very  little 
weight— was  that  the  holding  company  as  a  stockholder 
in  the  other  companies  was  entitled  to  the  benefit  of  all 
the  dividends  declared,  but  could  not  be  called  upon  to 
make  up  any  loss  that  might  be  sustained;  this  excuse 
ohvioiisly  overlooks  the  fact  that  the  loss  incurred  by 
the  fourth  company  constituted  a  diminution  of  the  as- 
sets of  the  holding  company.    A  firm  of  certified  pub- 
lic accountants  was  called  upon  to  sign  the  mislead- 
injr  re])ort  prepared  by  the  directors.    The  accountants 
Mere  given  access  to  the  books  of  the  holding  company 
hilt  were  refused  the  books  of  the  subsidiary  companies. 
The  firm  lost  the  audit,  which  went  to  more  pliable 
accountants  (not  holding  the  degree  of  certified  public 
accountant),  and  the  original  report  was  presented  to 
the  stockholders.    Presumably  the  directors  seized  the 
opportunity  to  sell  their  stock  in  the  holding  company 
at  a  high  price.     At  any  rate,  the  holding  company 
went  into  bankruptcy  not  long  afterwards. 

(h)  A  railroad  company,  when  the  time  for  the  annual 
repf)rt  and  audit  approached,  deliberately  withheld  the 
intertraffic  claims  of  other  companies,  amounting  to  a 


I 

r.  I 

ml 


422 


COUPOllATION  FINANCE 


considerable  sum,  by  simply  pigeon-holing  the  docu- 
ments  and  not  recording  them  as  a  part  of  their  current 
obligations.    This  action  was  taken,  it  is  stated,  by  order 
of  tile  executive  committee  of  the  board  of  directors,  who 
were  about  to  ask  authority  for  a  new  stock  issue  and 
who  desired  to  bring  out  the  issue  shortly  after  the 
annual  report  appeared.    The  certified  public  account- 
ants, who  had  charge  of  the  annual  audit,  in  this  case 
discovered  the  deception  through  a  general  analytical 
study  of  the  year's  operations  whereby  it  was  seen  that 
while  such  intertraffic  claims  ought  to  exist,  they  were 
not  in  evidence. 

(c)  An  industrial  company  was  enabled  to  maintain 
a  market  value  for  its  stock  through  the  payment  of 
unearned  dividends  out  of  capital.  The  deficit  was  not 
shown  on  the  books  and  was  not  known  to  the  stock- 
holders until  after  an  audit  by  public  accountants.  Its 
existence,  however,  should  have  been  known  to  the 
directors  and  in  all  probability  was  known  during  the 
period  in  which  unearned  dividends  were  declared.  In 
this  case  judgment  was  obtained  in  the  courts  against 
the  directors  and  restitution  of  the  unearned  dividends 
was  obtained. 

(d)  In  a  case  brought  in  the  federal  courts  stock- 
holders asked  for  the  cancellation  of  stock  alleged  to 
have  been  fraudulently  and  secr-tly  issued  by  the  board 
of  directors.  It  was  stated  that  a  person,  to  whom  the 
certificate  was  issued  without  consideration  to  the  com- 
pany, executed  to  one  of  the  directors  a  power  of 
attorney  authorizing  him  to  vote  the  stock  and  delivered 
the  certificate  signed  in  blank.  Thus,  although  no  trans- 
fer appeared  on  the  books  of  the  corporation,  the  stock 
was  actually  owned  and  voted  by  one  of  the  directors. 
As  the  stock  of  this  corporation  was  widely  scattered 


MANIPULATION  BY  DIRECTORS 


423 


and  as  the  reports  to  stockholders  were  fragmentary 
and  misleading,  the  whole  transaction  would  have 
passed  unnoticed  if  it  had  not  been  accidentally  re- 
vealed to  one  of  the  stockholders.  The  court  in  this 
case  merely  cancelled  the  certificate  in  question  and 
iieitiier  civil  nor  criminal  liability  was  found  to  attach 
to  the  directors. 

2.'}7.  An  accovntant's  observations. — A  certified  pub- 
lic accountant,  w^hose  experience  in  handling  such  cases 
has  been  exceptionally  large,  has  been  kind  enough  to 
sum  up  for  the  writer  the  results  of  his  observations  in 
the  following  note : 

The  methods  employed  for  the  purpose  of  giving  a  wrong 
impression  to  the  stockholders  or  the  public  as  to  the  company's 
condition  as  shown  by  the  published  balance  sheet  are  almost 
innumerable,  but  I  will  cite  a  few. 

Where  the  accounts  are  subject  to  audit  aiid  it  is  desired 
to  make  a  good  appearance  at  the  date  of  the  balance  sheet,  the 
practice  of  borrowing  a  large  sum  of  money  from  brokers  or 
bankers  for  a  few  days  is  often  resorted  to.  By  this  means  at 
tlie  date  of  the  balance  sheet  the  company  has  apparently  a 
lar/re  amount  of  available  funds,  though  in  point  of  fact  the 
loan  is  repaid  a  few  days  later.  In  the  same  way,  where  such  a 
corporation  as  a  loan  and  investment  company  finds  itself  hold- 
inff  securities  of  a  speculative  character,  such  as  mining  stock, 
it  is  (juite  customary  to  make  a  sale  of  these  securities  to  brokers 
a  few  (lavs  before  the  date  of  the  balance  sheet,  with  the  under- 
standing that  the  company  is  to  repurchase  them  at  the  same 
price  less  commission  for  the  accommodation  a  few  days  later. 
In  this  way  the  company  avoids  showing  on  its  published  bal- 
ance sheet  any  investments  that  are  not  of  a  gilt-edged  charac- 
ter, and  in  both  the  instances  quoted  above  it  is  very  hard  for 
the  auditor  to  find  any  grounds  for  refusal  to  give  an  unquali- 
fied certificate  to  the  balance  sheet ;  the  condition  is  as  stated  by 
the  accounts  at  the  particular  date  at  which  they  are  drawn  up. 


424 


CORPORATIOX  FIXAXC  E 


Again,  where  ,t  is  doMrcd  to  conceal  from  stockliolders  the 
fact  tliat  the  company  is  making  large  profits  or,  on  f 
hand,  incurring  heavy  losses,  the  valuation  placed  upon  .„vest 
ments  ,n  stocks  and  bonds  of  other  corporations  or  the  valua- 
tion placcl  ujjon  merchandise  on  hand  is  often  juggled,  the 
ofhcers  of  the  company  constituting  themselves  the  arbiters  as 
to  what  IS  really  the  actual  value  of  such  assets. 

Another  window-dressing  plan  often  emploved  is  to  treat 
the  balances  due  on  current  account  from  the  branch  houses  of 
the  corporation  as  though  they  were  accounts  receivable  due 
from  ordinary  customers.  Goods  on  consignment  arc  often 
smularly  treated  as  though  they  were  accounts  receivable  and 
included  in  the  balance  sheet  al  sale  price  under  this  caption 
instead  of  at  cost  price. 

238.  KemcdicH  for  this  kind  of  mauipulation.—SYhfii 
little  has  been  said  here  with  vcganX  to  juggling  ac- 
counts by  directors  is  sufficient  to  drive  home  at  least 
one  truth,  namely,  that  the  only  safety  for  stockholders 
lies  m  insisting  upon  frequent  and  thorough  examina- 
tions by  certified   i)ublic  accountants  of  the  highest 
standing.    The  chief  asset  of  a  public  accountant  is  his 
unquestioned  reputation  for  penetration  and  integrity. 
The  loss  of  that  reputation  means  the  loss  of  his  profes- 
sional standing  and  of  his  clientele.    He  has,  therefore, 
the  strongest  motive  to  lay  bare  the  true  condition  of 
any  corporation  which  he  is  called  upon  to  examine  and 
to  state  t!)c  exjict  facts  to  the  stcK-kholdors.    The  stock- 
holders may  safely  place  confidence  in  him— unless,  to 
be  sure,  he  happens  to  be  one  of  those  black  sheep,  a  few 
of  whom  find  temporary  employment  in  all  professions. 
In  England  it  is  customary  for  the  stockholders  them- 
selves to  elect  a  public  accountant  to  serve  as  the  annual 
auditor  of  their  company.     It  will  be  a  fortunate  day 
for  American  stockholders  when  this  practice  becomes 


MANIPULATION  BY  DIRECTORS 


425 


])revalent  also  in  this  country.  We  may  lay  it  down  as 
a  general  principle  that  officers  and  directors  who  are 
worthy  of  their  trust  will  not  object  to  having  their 
operations  scrutinized  at  least  once  a  year  by  an  impar- 
tial and  absolutely  independent  expert. 

Another  tendency  which  works  indirectly  toward  the 
same  result  is  the  growing  demand  on  the  part  of  the 
people  of  the  United  States  for  publicity  in  corporation 
affairs.  The  demand  for  publicity  is  especially  effec- 
tive in  the  case  of  railroads  and  other  public  ser\'ice 
corporations,  most  of  which  are  now  recpiired  to  render 
complete  annual  reports  either  to  the  Interstate  Com- 
merce Commission  or  to  some  corresponding  state  au- 
thority. The  primary  purpose  of  this  requirement  is 
(o  obtain  information  that  will  aid  legislatures  and  com- 
missions in  deciding  upon  reasonable  rates  and  prices. 
It  is  doubtful,  in  the  opinion  of  the  writer,  whether  this 
iisult  will  be  achieved.  There  a  be  no  question,  how- 
ever, but  that  the  interests  of  stockholders  of  such 
companies  have  been  greatly  advanced  by  a  general 
adoption  of  this  requirement.  It  is  now  possible  for  an 
investor  to  obtain  such  a  complete  and  authoritative 
knowledge  of  the  interior  affairs  of  the  principal 
American  railroads  as  to  make  possil)le  an  intelligent 
.judgment  of  the  honesty  and  efficiency  of  the  manage- 
ment. 

Seeing  the  advantages  that  are  thus  gained,  the 
stockholders  of  other  large  corporations  are  insisting 
more  and  more  forcibly  on  a  similar  publicity  and  in- 
vestors are  refusing  to  buy  the  securities  of  companies 
which  do  not  present  satisfactory  annual  reports.  That 
this  attitude  has  for  some  years  been  making  itself  felt 
nppears  from  the  numerous  conversions,  referred  to  in 
Chapter  XVII,  of  securities  quoted  on  the  Xi-w  York 


426 


CORPORATION  FINANCE 


Stock  Exchange  from  the  unh'sted  to  the  listed  group. 

239.  liijlictiny  loss  on  the  corporation.~The  fourth 
important  method  of  manipulation  by  directors  is 
througli  forcing  licavy  losses  and  frequently  even  bank- 
ruptcy on  tiicir  companies.  Here  again  a  few  examples 
selected  from  a  mass  of  cases  which  the  writer  has  ex- 
amined will  best  illustrate  the  principal  variations  of  this 
method. 

(a)  The  G.  and  R.  Railroad  Company,  a  Kentucky 
corporation,  constructed  a  road  from  Graceton  to 
Rawlings  for  which  it  was  heavily  indebted.  Robinson, 
a  director,  with  the  assistance  of  other  directors,  used 
the  i)rofits  of  the  road  to  make  improvements  and  thus 
made  impossible  the  payment  of  interest  on  the  outstand- 
ing bonds.  The  company  was  thus  force.l  into  bank- 
ruptcy and  at  the  bankrupt  sale  all  the  property  and 
rights  were  sold  to  Robinson.  Robinson  and  others 
then  formed  a  new  corporation  to  hold  the  road.  Five 
years  later  the  stockholders  of  the  bankrupt  corporation 
brought  suit  against  the  heirs  of  Robinson  to  have  the 
court  adjudge  the  road  as  held  in  trust  for  the  G.  and 
R.  Railroad  Company.  The  court  found  that  Robinson 
had  violated  his  duties  of  trust  by  willfully  mismanag- 
ing the  road  antl  nusappropriating  the  earnings  and, 
therefore,  returned  the  property  to  the  original  stock- 
holders, compensation  being  allowed  to  Robinson's  heirs 
for  the  amount  actually  paid  by  Robins(m  for  the  road. 
Evidently  Itobinson's  actions  in  this  instance,  al- 
though finally  declared  unlawful,  would  have  passed 
unchallenged  but  for  the  enterprise  and  persistencj'  of 
one  or  two  of  the  stockholders. 

(b)  In  a  recent  case  in  the  federal  courts,  certain 
trustees  of  a  building  and  loan  association  sold  a  valu- 
able piece  of  real  estate  to  a  trust  company,  in  which 


MANirULiVTION  BY  DIRECTORS 


427 


some  of  the  trustees  were  also  interested,  in  exchange 
tor  securities  of  doubtful  value.  A  mortgage  on  the 
real  estate  was  taken  from  the  trust  company  as  a 
guarantee  that  the  securities  would  realize  the  price 
agreed  upon  for  the  property,  but  by  agreement  the 
mortgage  was  not  renrded.  Later  the  trust  company 
desired  to  sell  the  property  and  the  trustees  passed  a 
resolution  authorizing  the  cancellation  of  the  mortgage, 
and  it  was  cancelled  without  the  knowledge  or  consent  of 
the  stockholders.  Shortly  afterwards  the  trust  com- 
pany became  insolvent,  the  securities  held  by  the  build- 
ing and  loan  association  were  foimd  to  be  worthless  and 
next  to  nothing  was  obtained  for  the  property  that  had 
been  sold.  This  may  be  taken  as  a  typical  instance 
of  loss  willfully  inflicted  on  a  corporation  by  its  own 
directors. 

(c)  A  corporation  was  indebted  to  its  directors  and 
they  caused  mortgage  bonds  to  be  issued  to  them  for 
the  indebtedness.  The  bonds  were  immediately  as- 
signed to  a  rival  corporation.  Before  anything  further 
had  been  done  the  stockholders  learned  of  this  trans- 
action and  brought  suit  for  damages.  The  court  held 
that  the  directors  would  be  personally  liable  for  what- 
ever consequences  of  their  acts  might  affect  injuriously 
the  interests  of  non-consenting  stockholders 

(d)  A  stockholder  of  a  Montana  mining  corporation 
in  an  action  alleged  that  officers  and  directors  in  pur- 
suance of  a  plan  to  depreciate  the  company's  stock,  in 
order  to  render  practically  worthless  siock  held  by  the 
plaintiff  and  others  similarly  situated,  refused  to  sell 
treasury  stock  of  the  corporation  in  order  to  procure 
funds  with  which  to  prosecute  assessment  work  on  the 
company's  mining  claims  essential  to  compliance  with 
the  state  and  federal  laws.    Further  the  directors  sys- 


428 


CORPORATION  FINANCE 


tematically  depreciated  the  value  of  the  treasury  stock- 
by  words  and  actions,  refused  to  accept  money  offered 
therefor,  removed  the  books  of  the  company  from  the 
state,  dechnea  to  give  the  plaintiff  any  information  re- 
garding the  company's  affairs  and  in  general  so  con- 
ducted Its  busmess  as  to  destroy  the  value  of  its  shares. 
Iheir  object  m  so  doing  was  to  make  it  necessary  for 
the  company  to  give  up  its  mining  claim  in  order  that 
they  might  re-locate  the  property  in  their  own  names. 
In  this  case  the  court  decided  that  fraud  had  been 
sufficiently  shown  and  placed  a  receiver  in  charge  of  the 
property.    The  decision,  however,  would  not  have  been 
reached  except  for  certain  imprudent  remarks  on  the 
part  of  some  of  the  directors. 

240.  The  danger  in  losing  control  of  a  corporation.- 
Ihe  most  mteresting  instance  t?iat  has  come  to  the 
writer  s  notice  is  given  by  a  certified  public  accountant 
m  one  of  the  Western  States,  who  vouches  for  its  being 
a  typical  and  actual  case  of  manipulation  bv  directors. 
He  writes  as  follows: 

A  ownrd  a  majority  of  the  capital  stock  outstanding  in  a 
manufacturing  concern.     Besides  himself  he  had  two  dummies 
for  the  two  other  members  of  the  board  of  directors.     B  de- 
sired to  buy  an  interest  in  the  concern  and  bought  less  than  half 
of  A  8  stock  (leaving  A  still  in  control),  with  the  understanding 
that  B  was  to  become  a  member  of  the  board  of  directors,  and 
that  A  and  B  should  select  another  person  whom  the.v  might 
interest  at  some  future  date  when  selling  more  st.uk.  *  There- 
fore, they  mutually  decided  to  place  a  dummy  temporarily  on 
the  board.      B   is  a  crook,  as  develops  afterwanls.      C   (the 
agreed-upon  dummy)  proves  to  be  a  bigger  crook  than  B,  thus 
givmg  B  a  majority  in  the  board  of  dinrtors.     After  this  ar- 
rangement has  been  carried  through,  B  and  C  trump  up  some 
imagmary  charges  against  the  methods  of  management  of  A, 


MANIPULATION  BY  DIRECTORS 


429 


and  thus  the  majority  of  the  board  depose  A  as  president  and 
iiirtiiager  of  the  concern.  A  opposes  the  action  and  the  case  is 
brought  into  the  court.  B  and  C  being  the  majority  of  the 
board  of  directors,  the  court  upholds  their  action  and  gives  an 
injunction  against  A  not  to  interfere  with  B  and  C. 

B  and  C  then  buy  some  worthless  vacant  property  for  a  few 
(lollurs,  which  they  appraise  at  an  excessive  value  and  sell  to  the 
company,  tak'  ^  stock  in  payment  at  the  increased  values. 
This  stock  is  ..en  divided  between  B  and  C,  thus  leaving  A  in 
tiie  minority  as  a  stockholder.  The  factory  then  burns  down 
and  a  low  settlement  is  made  with  the  insurance  companies,  be- 
cause suspicion  was  directed  toward  B  for  having  set  fire  to  the 
property.  Their  assets  having  thus  been  reduced,  and  wishing 
to  make  an  excellent  impression  upon  the  court,  and  further 
wishing  to  hide  their  fraudulent  action  in  placing  the  excessive 
value  on  the  vacant,  valueless  property,  they  decrease  the  capi- 
tal stock  to  about  10  per  cent  of  the  original  capital  stock. 
Kach  stockholder  obtains  his  proportionate  share  of  the  new 
stork.  In  this  manner  B  and  C  beat  A  from  a  half  interest  to 
a  sixth  interest. 

They  then  incorporate  a  new  company  called  The  Investment 
Company,  of  which  B  and  C  are  the  only  stockholders  and  in 
which  B  and  C  put  up  .^5,000,  which  they  loan  out  on  improved 
rialty  to  the  manufacturing  company,  obtaining  therefor  a 
note  secured  by  a  mortgage. 

They  then  proceed  to  incorporate  another  company,  which 
succeeds  the  old  manufacturing  company.  They  value  the  as- 
sets of  the  old  company  at  about  one-third  of  what  they  stand 
on  the  books.  The  new  company  purchases  the  assets  at  the  re- 
<lu«od  value,  giving  the  stockholders  of  the  old  comp  y  stock  in 
the  new  concern  in  proportion  of  one  to  three,  thus  reducing 
tlu'  holdingH  of  A  from  a  half  to  an  eighth  interest  in  the  same 
Hsstts  of  which  he  was  originally  the  owner.  The  new  company 
then  contracts  with  D,  who  is  another  crook,  to  build  it  a  fac- 
tory. The  contract  made  with  him  is  at  a  figure  which  in  about 
$5,000  higher  than  the  ordinary  contractor  would  have  built  it 


Hi 


430 


CORPORATION  FINANCE 


for.  In  addition  to  this  B  and  C  give  him  a  large  block  of  stock 
as  a  part  consideration  for  the  building  of  the  plant.  This 
$5,000  in  excess  of  the  real  cost  of  the  factory  is  paid  to  D 
every  other  day  in  cash  and  the  books  ir.dicate  that  such  cash 
was  for  his  pay-roll.  But  circumstantial  evidence  points  to  the 
fact  that  these  payments  are  bogus  transactions  on  the  books 
and  that  in  fact  the  money  goes  into  the  bank  account  of  the 
Investment  Company. 

Then  the  Investment  Company  begins  to  play  treasurer  for 
the  new  company,  because  it  has  no  funds.  Thus  it  loans  the 
$5,000  back  to  the  manufacturing  company.  The  new  manu- 
facturing company  needing  more  funds,  the  Investment  Com- 
pany sells  the  $5,000  note  above  mentioned  to  the  manufactur- 
ing company,  permitting  the  manufacturing  company  to  credit 
the  Investment  Conij)any  for  this  $5,000  on  its  books.  The 
manufacturing  company  then  puts  up  the  $5,000  note  as  col- 
lateral for  a  loan  of  .$3,000  at  the  Bank.  The  result  is  that 
the  Investment  Company  secures  a  credit  in  its  favor  for  $5,000 
for  an  actual  value  of  but  $3,000.  After  this  transaction  the 
Investment  Company  shows  signs  of  anxiety  for  the  money  it 
has  advanced,  $5,000  in  cash  and  $5,000  in  notes.  It  there- 
fore secures  its  claims  by  a  njortgage  from  the  manufacturing 
company  on  its  new  plant  for  $10,000. 

The  plant  is  completed,  the  stock  bonus  issued  to  the  contrac- 
tor, and  this  stock  transferred  to  the  Investment  Company. 
Circumstantial  evidence  shows  that  no  consideration  was  paid 
by  the  Investment  Company  to  the  contractor  for  this  stock. 
As  the  case  stands  at  present,  the  Investment  Company  is  try- 
ing to  foreclose  its  mortgage  and  if  successful,  will  entirely  de- 
feat the  interest  of  A,  who  in  less  than  eight  months  was  lK>aten 
out  of  a  more  than  half  interest  in  a  successfully-run  factory. 

I  was  employed  in  this  case  by  order  of  the  court  upon  the 
complaint  of  A  that  B  and  C  were  waiting  the  assets  of  the 
company.  I  cannot  see  how  umler  the  laws  of  the  state  A  has 
nny  redress  whatever,  except  to  show  fraud  in  the  first  issue  of 
additional  stock  and  in  the  subsctjuent  decreasing  of  the  capital 


MANIPULATION  BY  DIRECTORS 


431 


stock.  But  from  the  point  of  view  of  law  it  will  be  exceedingly 
dirticult  to  bring  in  this  evidence.  However,  there  is  a  ray  of 
hope  in  the  horizon ;  namely,  that  the  state  statutes  forbid  the 
directors  to  put  a  mortgage  on  a  mining  or  manufacturing 
plant  without  calling  a  special  stockholders'  meeting  and  ob- 
taining the  consent  of  two-thirds  of  the  stock.  These  directors 
had  two-thirds  of  the  stock  and  could  have  easily  complied  with 
the  requirement  but  their  attorney  evidently  overlooked  this 
point  and  we  believe  that  we  can  have  this  mortgage  set  aside 
and  a  receiver  appointed.  In  this  case  the  receiver  could  start 
suit  against  B  and  C  and  then  bring  out  these  fraudulent  tran- 
sactions. 

The  cases  that  have  been  cited  seem  scarcely  to  call 
for  comment.  They  all— and  especially  the  last  case- 
however,  give  point  to  one  precept,  which  controlling 
stockholders  would  do  well  to  keep  before  them,  namely 
DO  NOT  PART  \MTH  CONTROL.  A  swindling  or  hostile 
board  of  directors  can  do  more  in  one  session  to  wreck 
a  corporation  and  bring  loss  to  its  honest  stockholders 
than  a  capable  board  can  accomplish  in  years  toward 
repairing  the  damage. 

241,  Form  of  annual  statements  in  Canada. — Those 
interested  in  Canadian  corporation  finance  have  scope 
for  considerable  improvement  in  the  form  of  presentation 
of  their  annual  statements.  An  examination  of  such 
statements  issued  during  any  one  year  reveals  numerous 
differences  in  the  method  of  presenting  these  statements. 
It  would  not  be  so  surprising  to  find  differences  between 
the  financial  statements  of  concerns  carrying  on  busi- 
iiisses  of  different  natures,  but  there  docs  not  seem  to 
he  a  great  deal  of  room  for  wide  variation  between  those 
of  firms  carrying  on  exactly  the  same  nature  of  business. 

Bearing  in  mind  that  the  object  of  a  financial  state- 
ment should  be  to  place  before  the  shareholders  or  the 


432 


CORPORATIOxX  FINANCE 


II 


public,  generally,  the  exact  position  of  the  company  at 
a  certain  date,  there  should  he  no  great  difficulty  in  pre- 
senting the  various  figures  in  such  a  manner  as  to  ac- 
complish this  object.  It  will  not  be  disputed,  that  in  a 
large  number  of  instances  this  is  not  done,  and  one  might 
safely  assert  that  in  the  majority  of  instances  financial 
statements  leave  much  to  be  desired. 

Some  examples  of  these  lackings  in  the  financial  state- 
ments of  some  of  the  best-known  concerns  in  Canada 
follow : 

Various  industrial  concerns,  which  for  years  were  the 
recipients  of  bounties  from  government,  made  no  state- 
ment of  the  sums  received  (m  this  account  in  their  annual 
reports,  but  included  them  as  profits. 

A  large  industry  first  shows  its  dividends  paid  and 
later  shows  the  amount  (;f  rent  paid. 

Almost  fifty  per  cent  of  Canadian  financial  statements 
show  somewhere  near  the  top  of  the  column  the  amount 
brought  forward  from  the  previous  year,  afterwards 
adding  thereto  the  profits  of  the  current  year  before 
making  the  necessary  deductions. 

Probably  as  large  a  proportion  show,  first,  the  divi- 
dends paid  and  afterwards  make  their  appropriations  for 
depreciation  and  other  reserves. 

This  is  not  sufficient.  Take,  for  instance,  the  first 
group  mentioned.  It  would  hardly  be  possible  for  any- 
one, not  knowing  that  a  firm  was  the  recipient  of  a  gov- 
ernment bojmty,  to  form  a  correct  conclusion  concerning 
that  firm's  earning  capacity  if  the  financial  statement 
made  no  mention  of  bounties,  but  simply  represented 
them  as  earnings. 

242.  JVhnt  should  he  incIiiitctJ  in  the  statement. — Mr. 
T.  C.  Allum,  the  IMontreal  correspondent  of  the  Mone- 
tary Times  of  Canada,  discussing  this  matter,  says: 


MANIPULATION  BY  DIRECTORS  433 

One  first  looks  at  a  statement  to  ascertain  what  the  earnings 
of  the  current  year  were.  First  must  be  represented  receipts 
duo  to  the  nature  of  the  business.  After  this  may  be  shown  the 
costs  of  operation,  divided  into  as  many  general  headings  as 
jRiniissible.  The  total  of  these  itemized  costs  is  shown  and  is 
tlien  deducted  from  the  receipts  of  gross  earnings.  The  re- 
niiiiiider  is  the  gross  profits.  Then  should  be  shown,  earnings 
from  other  sources  which  may  be  considered  as  regular  and 
reasonably  dependable.  Then  may  be  shown  expenses  of  sale  or 
iiiaimffcment,  the  remainder  being  the  net  profits  from  opera- 
tions. All  these  items  should  follow  regularly  and  systemati- 
cally, much  as  they  would  occur  in  the  conduct  of  the  business. 

Then  would  be  shown  the  bond  interest  and  other  fixed 
charges.  This  being  deducted  from  the  net  profits  from  opera- 
tions, would  show  the  surplus  or  deficit  for  the  year.  This  is 
probably  what  the  shareholder  has  been  looking  for.  It  is  also 
wliat  the  bondholder  is  looking  for.  Both  are  desirous  of  know- 
ing what  shape  the  company  is  in  after  all  the  charges  have 
birn  met,  which  the  company  is  obligated  to  pay  during  oper- 
ations or  on  certain  stated  dates. 

243.  Quarterly  statements.— There  is  some  disposi- 
tion in  Canada  for  large  corporations  to  issue  quarterly 
statements  to  shareholders,  as  is  done  by  many  companies 
in  the  United  States.  The  Dominion  Steel  Corporation 
issued  the  first  of  such  statements  concerning  the  opera- 
tions of  the  company  for  the  first  three  months,  ended 
June  30,  of  the  company's  year.  The  statement  did 
not  give  any  further  particulars  than  the  amount  avail- 
al)le  for  dividends  and  dividends  paid.  The  figures  were: 

Karnings  available  for  dividends $705,262 

Dividends  on  preferred  stocks 245,000 

n.1nno. ^♦60,262 

1  per  cent  dividend  on  common 818,977 

$141,285 
C— VI— 28 


^34 


CORPORATION   FINANCE 


There  is  a  division  of  public  oxjinion  in  Canada  on 
the  advisability  of  such  reports,  however.  One  of  the 
leading  corporation  presidents  of  this  country  is  of  the 
opinion  that  tlie  United  States  Steel  Corporation  is 
not  a  guide  for  any  ordinary  company.  With  their 
enormous  business,  numerous  plants,  located  at  different 
points,  owning  their  own  railways,  coal  mines,  ore  de- 
posits, and  other  properties,  they  can  keep  their  state- 
ments practically  regular  from  month  to  month.  "The 
shares  of  our  Canadian  industrial  companies,"  he  added, 
"are  largely  held  for  investment,  and  these  holders  are 
quite  content  with  annual  reports.  Monthly  reports 
would  be  misleading,  as  owing  to  a  strike  or  fire  or 
changing  from  one  contract  to  another,  some  months  do 
not  show  any  profit  at  all,  and  monthly  reports  would 
simply  enable  the  brokers  to  'bear'  the  stock  in  bad 
months.  This  would  induce  frightened  shareholders 
to  sell,  and  in  good  months  the  stock  would  be  boomed 
and  perhaps  the  same  persons  who  sold  the  stock  at  a 
low  price  would  buy  it  back  at  a  higher  price." 


CHAPTER  XXVIII 

MANIPULATION  BY  AND  FOR  STOCKHOLDERS 

244.  Cheating  creditors. — The  subject  matter  of  this 
chapter  is  concerned  with  manipulation  directed  toward 
one  of  two  objects;  either  toward  depriving  creditors 
of  some  of  their  just  rights  for  the  benefit  of  the  body 
of  stockholders ;  or  toward  increasing  the  profits  of  con- 
trolling stockholders  at  the  expense  of  minority  inter- 
ests. In  the  first  case  the  stockholdei  j  may  be  either 
acting  as  a  body,  or  manipulation  carried  on  primarily 
for  the  benefit  of  the  majority  stockholders  may  be 
of  such  a  character  that  the  minority  can  successfully 
obtain  a  share  in  its  advantages.  Generally  speaking, 
manipulation  by  and  for  stockholders  as  a  body  is  con- 
fined to  small  close  corporations.  We  shall  find,  how- 
ever, one  or  two  notable  exceptions  to  this  rule. 

We  are  all  of  us  familiar,  some  of  us  perhaps  to  our 
loss,  with  the  old  trick  of  an  individual  or  partnership 
buying  stock  of  goods  on  credit,  disposing  of  it  quickly 
and  secretly,  concealing  the  returns  and  shortly  after- 
ward going  into  bankruptcy.  The  trick  may  be  worked 
by  corporations  as  well  as  by  partnerships  or  by  in- 
dividuals. Indeed,  the  corporation  affords  an  additional 
advantage  to  the  swindlers  in  that  its  bankruptcy  need 
not  affect  them  in  the  least.  Credit-men  understand 
tbe  game  in  all  its  variations  thoroughly  and  are  es- 
pecially cautious  in  granting  credit  to  small  close  cor- 
porations, no  matter  how  imposing  may  be  their  title 
and  the  capitalization.    This  scheme,  of  course,  is  simply 

485 


436 


C:ORPORATION  FINANCE 


a. 

I 
■f. 

f, 


a  plain  case  of  fraud  and  has  no  especial  interest  for 
us  in  this  study. 

A  slightly  different  method  of  reaching  much  the 
same  result  is  to  have  a  corporation  pile  up  a  large  debt 
on  the  strength  of  its  assets  and  then  to  allow  the  assets 
to  depreciate.  Stockholders  of  a  corporation  whose  out- 
standing bonded  debt  is  high  are  always  under  tempta- 
tion to  encourage  this  policy  By  so  doing  they  may 
secure  large  dividends  for  themselves  over  a  series  of 
years  and  at  the  end  leave  assets  of  small  value  to  satisfy 
the  bondholders.  As  we  have  already  found  in  our 
study  of  corporate  mortgages  (Chapter  IX)  properly 
drawn  instruments  of  this  character  provide  that  the 
property  mortgaged  shall  be  maintained  in  at  least 
as  good  condition  as  at  the  time  that  the  mortgage  is 
drami,  on  penalty  of  having  the  corporation  put  into 
the  hands  of  receivers.  If  the  trustee  under  the  mort- 
gage performs  his  duties  properly  he  will  see  to  it  that 
this  provision  is  enforced.  If  the  stockholders  and 
directors  acting  for  the  stockholders  really  desire  to 
evade  the  provision,  it  may  require  the  closest  atten- 
tion and  rigorous  action  on  the  part  of  the  trustee  to 
forestall  them. 

245.  The  Chicago  and  Alton  deal — The  well-known 
instance  of  the  Chicago  and  Alton  Railroad  deal 
illustrates  another  variation  of  the  same  principle.  The 
facts  with  regard  to  the  Chicago  and  Alton  manipula- 
tion which  were  fully  brought  out  in  an  investigation  by 
the  Interstate  Commerce  Commission  in  1907,  may  be 
briefly  summarized  as  follows:  A  close  syndicate  in 
1898  bought  about  80  per  cent  of  the  outstanding  com- 
mon stock  of  the  Chicago  and  Alton  Railroad  Company. 
The  company  had  been  managed  with  great  conserva- 
tism for  several  years  and  had  saved  from  its  earnings 


MANIPULATION  BY  STOCKHOLDERS 


437 


and  put  back  into  the  property  a  surplus  of  $12,500,000. 
\()\v  a  surplus  is  legally,  of  course,  the  property  of  the 
stot'kliolders  of  a  corporation.     It  is  so  unusual,  how- 
ever, for  stockholders  to  distribute  this  surplus  directly 
to  themselves  that  bondholders  naturally  look  upon  it 
as  in  part  a  protection  to  themselves  and  buy  bonds 
with  that  imderstanding.     Ordinarily,  as  has  been  ex- 
phiined,  the  surplus  is  invested  in  the  form  of  perma- 
Ment  assets  of  the  corporation,  and  the  value  of  these 
assets  is  a  strong  factor  in  influencing  the  bond  buyer. 
The  syndicate  of  common  stockholders  in  this  case,  de- 
termined to  secure  for  themselves,  and  incidentally  the 
other  stockholders,  the  accumulated  surplus  of  the  com- 
puTiy.    They  therefore  issued  new  bonds  to  the  extent  of 
.S.'}2,000,000,  which  were  sold  at  65  and  the  proceeds, 
about  J^^'i  1.000,000,  turned  into  the  company's  treasury. 
They  then  deelared  an  extra  cash  dividend  of  30  per 
eeiit  and  tlius  transferred  a  large  share  of  the  cash  ob- 
tained by  the  bond  issue  into  their  own  pockets.    The 
action  was  much  discussed  at  the  time,  was  condemned 
by  some  and  defended  by  others,  but  did  not  arouse 
much  public  interest  until  the  investigation  by  the  Inter- 
state Commerce  Commission  in  1907  brought  it  into 
prominence.     Then,  probably  to  the  surprise  of  the 
members  of  the  syndicate,  the  verdict  was  practically 
unanimous  against  them.     They  were  tried  before  the 
bar  of  public  opinion  and  were  found  guilty  of  misuse 
of  corporate  funds  which  had  been  entrusted  to  their 
eare.    There  can  be  no  question  but  that  this  unanimity 
on  the  part  of  the  public  is  highly  significant.     It 
means  that  betv>'een  1898  and  1907  a  notable  gain  in  the 
public's  knowledge  of  corporation  finance  and  in  the 
public's  conception  of  what  is  and  what  is  not  justifiable 
had  taken  place.     The  gentlemen  who  composed  the 


438 


CORPORATION  FINANCE 


u 


syndicate  ought  not  to  l>f  too  severely  criticised,  for  they 
ineiely  acted  in  accordance  with  the  custom  of  the 
period.  AVe  may  well  hope  and  believe  that  manipula- 
tion of  this  kind  and  of  the  other  kinds  that  have  been 
enumerated  will  become  less  and  less  frequent  as  our 
conceptions  of  the  trusteeship  implied  in  almost  aU 
corporate  activities  become  clearer. 

246.  Manipulation  through  snbsidianj  companies.— 
Another  method   that  is   very  commonly  used  when 
stockholders  plan  to  get  the  better  of  the  creditors  of 
their  corporation,  is  the  device  of  interposing  one  or 
more  corporations  between  the  creditors  and  the  assets 
on  which  they  think  they  have  a  claim.    A  case  in  point 
which  was  recently  settled  out  of  court,  and  in  which 
the  names  of  the  parties  concerned,  therefore,  cannot 
here  be  given,  is  that  of  an  amusement  company  operat- 
ing a  large  park  in  one  of  the  cities  of  the  United  States. 
The  operation  of  the  park  was  extremely  costly  and,  as 
the  price  of  admission  was  only  ten  cents,  the  returns 
were  not  sufficient  to  pay  expenses.    There  were,  how- 
ever, a  large  number  of  shows  and  amusement  enter- 
prises in  the  park  which  were  highly  profitable.    The 
stockholders  of  the  corporation   as   individuals  were 
interested  in  these  sideshows  and  secured  large  profits. 
The  corporation  which  owned  the  park,  on  the  strength 
of  its  apparent  prosperity,  was  able  to  borrow  large 
amounts  of  money.    When  the  time  Tor  settlement  came 
the  creditors  learned  the  true  state  of  affairs  and  were 
informed  that  their  claims  were  practically  worthless. 
Fortunately  in  this  case  they  were  able  to  bring  such 
pressure  to  bear  on  the  stockholders  that  their  claims 
were  settled.     It  is  cpiite  evident,  however,  that  as  a 
method  of  getting  loans  and  avoiding  re-payment  the 
scheme  is  workable. 


MANIPULATION  BY  STOCKHOLDERS 


4:J9 


Here  is  another  instance  which  shows  that  eminent 
and  entirely  respectable  railroad  'li'xctors  are  not  above 
working  the  same  trick  for  th«  'netit  of  their  road. 
The  \.  K.  Railway  owned  a  m  -  ^  »rity  of  the  stock  of 
a  small  rail  and  boat  line  whicii  had  income  bonds 
outstanding.  The  large  company,  being  in  control, 
was  able  to  apportion  traffic  and  earnings  as  it  pleased 
and  gave  less  than  its  share  to  the  small  line.  Three  of 
Mie  boats  owned  by  the  small  company  were  being  paid 
for  on  the  installment  plan  and  one  of  these  payments 
was  allowed  to  lapse,  thereby  forfeiting  the  interest  of 
the  small  company  in  the  boats.  The  large  railroad 
company  then  bought  the  boats  from  the  vendors,  being 
allowed  the  amount  which  had  already  been  paid  by  the 
small  company.  Then  a  consolidation  of  the  large  and 
the  sniall  companies  was  determined  upon  and,  as  the 
earnings  of  the  small  company  had  been  practically 
stopped,  its  shareholders  received  only  one  share  in  the 
new  consolidated  company  for  every  ten  shares  in  their 
])(>ssession.  The  income  landholders  received  no  interest 
after  the  large  company  came  into  control  and  when 
the  consolidation  took  place  were  compelled  to  consent 
to  a  great  reduction  of  their  claims.  The  case  was 
threshed  out  in  the  courts  and  it  was  decided  that  all  the 
steps  taken  were  legal,  except  the  voluntary  passing  of 
the  payment  on  the  boats. 

247.  Central  of  Georgia  income  account. — Another 
case  in  point,  that  several  years  ago  attracted  a  great 
deal  of  attention  in  the  financial  world,  was  set  forth 
in  the  suit  of  income  bondholders  of  the  Central  of 
Georgia  Railroad  Company  for  the  payment  of  inter- 
est in  full  on  the  bonds.  The  reader  will  recall  that 
in  describing  the  uutiire  f)f  income  bonds  it  was  stated 
that  they  are  falling  into  disuse  on  account  of  the  in- 


440 


CORPORATION   FINANCi: 


evitahle  disputes  that  arise  as  to  what  are  and  what  are 
not  profits.  The  bonds  in  question  were  issued  in  1895 
at  the  time  of  the  reor^ranization  of  the  ohl  Central 
Railroad  and  IJanking  Company  of  Georgia. 

This  ease  well  illustrates  the  subject  now  under  dis- 
cussion, inasmuch  as  it  discloses  one  method  of  i  lanipula- 
tion  in  favor  of  stockholders  at  the  expense  of  creditors. 
The  principal  fact  alleged  by  counsel  for  the  income 
bondholders,  and  practically  admitted  by  the  railway 
company,  was  that  a  subsidiary  corporation,  the  Ocean 
Steamship  Company,  almost  ail  of  the  stock  of  which  is 
owned  by  the  Central  of  Georgia  Railway  Company, 
had  been  making  large  profits  and  that  these  profits 
had  been  appropriated  by  the  railway  company.    Evi- 
dence disclosed  that  the  Ocean  Steamship  Company 
kept  no  separate  bank  account  but  deposited  all  its  funds 
to  the  credit  of  the  Central  of  Georgia  Railway  Com- 
pany.   There  were,  however,  separate  books  of  account 
for  the  two  companies  and  it  was  claimed  at  the  suit, 
on  behalf  of  the  railway  company,  that  the  earnings  of 
the  steamship  company  were  simply  loaned  to  the  parent 
corporation.    These  earnings,  the  reader  should  under- 
stand, were  not  used  in  order  to  declare  dividends  on  the 
stock  of  the  Ocean  Steamship  Company  held  in  the 
treasury  of  the  railway  company,  but  were  turned  over 
bo<lily  under  the  fiction  of  a  "loan";  therefore,  the 
earnings  of  the  steamship  company  did  not  appear  at  all 
in  the  income  account  of  the  railway  company,  and  the 
railway  company  thereby  avoided   showing  sufficient 
profits  to  pay  interest  to  the  income  bondholders.    The 
counsel  for  the  railway  company  urged,  according  to  the 
brief  of  T)etitioners'  counsel,  "that  the  net  earnings  of 
the  steamship  company  should  not  be  included  in  the 
income  account  of  the  railway  conpany  and  that  unless 


MANIPULATION  BY  STOCKHOLDERS 


441 


a  dividend  is  declared  by  the  steamship  company  no  part 
of  the  net  earnings  of  the  steamship  company  behm^ 
id  the  railway  company  or  are  pledged  to  the  hond- 
liolders,  and  that  the  question  of  declaration  of  a 
dividend  is  a  matter  of  discretion  lodged  with  the  board 
^)i'  directors  of  the  steamjjiip  company,  with  which  a 
roiirt  of  ecjuity  shoidd  not  interfere.  In  other  words, 
llie  railway  company  interposes  the  doctrine  of  'corpo- 
late  entity'  and  desires  to  have  what  it  regards  as  the 
'  uredness'  of  the  doctrine  taken  cognizance  of  by  a 
court  (»f  ecpiity." 

The  decision  of  the  court  in  this  case,  which  was  ren- 
dered after  hmg  and  hard-fought  litigation,  was  in 
lavor  of  the  complaining  bondholders.  It  would  cer- 
tainly seem  clear  to  a  lavman  that  the  subsidiary  cor- 

•  »  • 

|)i nation  was  here  used  as  a  device  to  preveni  the  in- 
come b(»ndliolders  from  securing  profits  justly  due. 

These  cases  are  sufficient  to  sh«)W  what  risks  creditors 
may  unwittingly  take  on  themselves  and  how  careful 
tlicy  should  be  in  fixing  tiie  terms  of  their  mortgage. 
KiSj)eeially  is  this  true  in  dealing  with  corporations  which 
carry  on  several  activities  and  which  may  through 
s'  pa  rate  companies  readily  divert  their  earnings  from 
the  rightful  creditors  to  the  stockholders. 

248.  S</ucc',in(j  the  miuoritf/  iitockh()I(hr)(.—\Vc  are 
r<  ady  now  to  take  up  the  second  group  of  Uianipulative 
iiK'thods  to  be  discusse<l  in  this  chapter,  namely  those 
mctlxMls  which  are  designe*!  t«»  enrich  controllitig  stock- 
hohUrs  at  the  expense  of  minority  interests.  Let  us 
consi<l''r  first  the  following  instance,  taken  from  a 
Missouri  cf)urt  decision,  of  willful  mismnnngemrnt: 

The  ()lymj)ie  Theatre  C\Mupany  was  or^  tni/ed  in 
May,  won,  with  a  capitalization  of  $.')0.000.  E.  S. 
.Fames,  .Sr.,  obtained  'HO  shares,  par  value  $100,  and 


I; 


'1 


U2 


CORPORATION   FINANCE 


,ii 


J.  S.  lAIcIntosh,  1.50  shares;  the  other  100  shares  were 
never  issued.     Three  days  after  the  or^ranization  the 
eoiii|)any  obtained  a  hundred-year  lease  ol'  a  lot  in  St. 
i.ouis.     Under  the  terms  of  the  lease  the  company  was 
to  i)ay  the  owner  a  rent  of  .$2,.>00  for  the  first  two  years 
and  thereafter  at  the  rate  of  «  per  eent  of  the  appraised 
value  of  the  lot.     The  company  had  the  ri^dit  to  pur- 
chase at  the  appraised  value  at  the  end  of  five  years. 
The  lease  was  to  heeoine  void  by  non- performance  of 
any  of  its  conditions  and,  in  the  event  of  its  being 
voided,  the  owners  of  the  lot  were  to  ^'et  full  title  to 
whatever  buildin^rs  the  theatre  company  mi^ht  erect  on 
the  lot.    The  company  erected  a  building  and  conducted 
a  theatre. 

In  100.>  Mcintosh  sold  his  stock  to  Robert  Henry, 
and  Ileiuy  became  a  director  and  treasurer  of  the 
compiiny.  K.  S.  James  ^rave  ten  shares  of  stock  to  his 
son,  K.  S.  James.  Jr.,  and  made  him  the  thin!  director. 
In  15)07  James,  Sr.,  transferred  ten  shares  to  another 
son,  Alfred  .James,  and  ten  shares  to  a  clerk,  L.  R. 
()s^(K)d.  In  the  snuw  year  the  new  board  of  directors 
elected  were  .lames.  Sr.,  James.  Jr.,  and  Osgood,  thus 
forein«r  IKnry  out.  In  lOOH,  as  the  company  was  not 
strong  enou^di  financially  to  buy  the  lot.  the  stockholders 
gave  the  directors  the  i  ight  to  dispose  of  the  company's 
option  to  any  stockholder.  The  directors  immediately 
sold  the  option  for  >^M)  to  .Tames,  Sr.,  who  there- 
upon resigned  as  |>re.si(lent  and  director  and  had  his 
son  Alfred  elected  in  his  place.  James.  Sr..  then  used 
his  option  to  buy  the  lot  for  J'^.jO.OOO  and  made  an  agree- 
ment with  th<-  company  fixing  its  appraised  value  at 
$rM.000  and  its  amui.il  rcntMJ  at  ^H.MH).  Alfred  .Tames 
then  resigned  his  offices  afid  his  fat!)er  was  re-elected 
president  and  direet«.r.     The  board  failed  to  pay  the 


MANIPULATION   HV  STOCK IIOLDKKS 


UH 


mil  when  due  and  Janses,  Sr.,  as  owner  of  the  lot  under 
the  lerins  of  the  lease  to  the  couiiiany,  declared  the  lease 
void  and  was  placed  in  possession  of  the  lot  and  the 
hiiildin^  erected  thereon.  Henry,  the  minority  stock- 
liolder,  hrought  suit  and  it  was  finally  decided  that  sufR- 
cieut  evidence  of  fraud  had  heen  produced  to  warrant 
the  court  in  reinstating  the  lessee  in  possession  of  the 
tiieatre  under  the  terms  of  the  lease. 

It  may  he  inferred  from  the  decision  that  two  factors 
which  decided  the  court  in  favor  of  the  plaintiff  were, 
first,  that  the  James  family  were  evidently  acting  as  a 
unit,  and,  second,  that  the  books  of  the  corporation  had 
l»((  11  destroyed.  These  were  tactical  errors  which  might 
readily  have  heen  avoided;  if  they  had  not  been  present, 
it  is  safe  to  say  that  the  whole  series  of  transactions 
would  have  been  found  legal. 

A  more  simple  anrl  common  case  is  stated  in  a  recent 
decision  of  one  of  the  federal  circuit  courts.  The  officers 
and  owners  of  a  majority  of  the  stock  of  a  wire  company 
\oted  as  stockholders  to  lease  the  property  of  the  com- 
pany at  a  low  rental  to  another  corporation,  all  of  whose 
stock  was  held  by  these  same  majority  stockholders.  Xo 
frajid  was  siu)wn  and  the  petition  of  the  minority  stock- 
holders to  set  aside  the  lease  was  not  granted. 

In  another  federal  court  case  it  was  shown  that  the 
majority  stockholder  of  a  gas  company  absolutely 
dominated  the  board  of  directors  and  in<luceil  the  board 
to  purchase  worthless  bonds  of  nnother  corporation  in 
AJiieli  he  was  interested,  i.y  which  he  was  able  to  make 
a  large  individual  profit.  Here  again  the  minority 
sloekiiolders,  in  spite  of  their  unremitting  efTorts,  were 
unable  to  prove  fraud. 

'J-tO.  A  com  pi  hat  I'd  real  rntatc  propoHition.  Here 
is  an   instance   furnished  bv  a   prominent   accoimtant 


■a- 


444 


CORPORATION  FINANCE 


and  which  is  stated  to  be  typical  of  the  operations 
of  a  certain  group  of  companies.  The  Suburban 
Development  Company  is  a  close  corporation  which 
speculates  in  acreage  and  sells  lots  on  a  commission 
basis.  The  company  sells  a  piece  of  property  belonging 
to  an  outsider,  Smith,  to  the  Redbank  Realty  Company. 
This  last  named  company  is  in  reality  a  subsidiary 
corporation,  all  of  whose  stock  is  owned  by  the  Suburban 
Development  Company.  The  Suburban  Development 
Company  collects  a  commission  from  Smith  for  selling 
his  property. 

The  company  now  organizes  a  third  corporation,  the 
Long  View  Land  Company,  which  buys  the  property 
at  a  handsome  advance  and  assumes  the  mortgage 
which  was  on  the  property  when  Smith  owned  it.  The 
Long  View  Land  Company,  in  addition  to  assuming 
the  mortgage,  issues  all  its  stock  to  the  Suburban 
Development  Company  for  the  balance  of  its  ])urchase 
price.  The  Long  View  I^and  Company  now  makes  a 
contract  with  the  Suburban  Development  Company 
whereby  the  last-named  corporation  sells  the  lots  on  a 
commission  of  20  per  cent.  The  I^ong  A^iew  Land 
Company  is  also  charged  an  exorbitant  amount  for 
office  rent  and  pays  large  salaries  to  its  officers,  who  are 
the  stockholders  in  the  Suburban  Development  Com- 
pany. 

The  Suburban  Development  Company  now  pushes 
the  sales  of  the  lots  owned  by  the  I^ong  View  I^and  Com- 
pany. When  no  outsiders  can  l)e  induced  to  buy.  other 
subsidiary  corporations  are  formed  which  buy  lots  at 
high  prices  from  the  Tiong  View  I^and  Company. 
Thus  this  company  is  given  a  fictitious  appearance  of 
great  pr»)sperity  and  a  surplus  is  created  on  the  Ixmks, 
With  such  n  showing  it  is  easy  to  find  purchasers  of  the 


MANIPULATION  BY  STOCKHOLDERS 


445 


stock  of  the  Long  View  I^ard  Company,  which  is  in  the 
ticasury  of  the  Suburban  Development  Company. 
After  all  but  the  controlling  shares  are  sold,  the  sub- 
sidiary companies  which  have  bought  lots  from  the  Long 
View  Land  Company  go  into  bankruptcy,  the  lots  are 
returned  and  the  paper  profits  of  the  Long  View  Land 
Company  suddenly  vanish  into  thin  air. 

The  object  of  this  complicated  series  of  transactions, 
as  the  reader  will  see,  is  simply  to  sell  the  minority  stock 
of  the  Long  View  Land  Company.  The  majority 
shares  must  be  retained  in  the  hands  of  the  manipulators 
ill  order  to  avoid  investigation  and  litigation.  The  com- 
pany advertised  and  kept  before  the  public  in  all  these 
transactions  is,  of  course,  the  Long  View  Land  Com- 
pany. All  the  time,  however,  the  stockholders  of  the 
tontrolling  corporation  are  calmly  pocketing  all  the 
rial  profits. 

The  alwve  illustrations  are  typical.  It  would  seem 
impossible  to  enumerate  all  the  possible  variations  in 
method.  The  feature  common  to  them  all,  however,  is 
the  transfer  of  property  from  one  corporation  to  another 
corporation  owned  by  the  majority  stockholders  of  cor- 
poration number  one.  This  is  what  the  minority  stock- 
holder must  always  fear  and,  so  far  as  possible,  provide 
apiinst.  There  is  no  other  way  of  preventing  such 
manipulation  except  by  associating  only  with  honest 
majority  stockholders  in  companies  where  the  fullest 
piil)licity  obtains. 

ti.)0.  Rohhiny  a  partuiiHhip  to  pay  a  anporatitm. — 
One  more  instance  should  be  added  to  the  list  already 
;,'i\en.  for  it  shows  very  clearly  what  may  be  accom- 
plished in  the  way  of  defrauding  helpless  and  ignorant 
minority  owners. 

.Tames  Khrenbahn,  a  partner  in  the  firm  of  L.  A. 


446 


CORPORATION  FI\A\(  i: 


Ehrenbahn  and  Company,  manufacturers  of  agricul- 
tural  implements,  died  in  the  year  189(5.     He  had  an 
undivided  one-fourth  interest  in  the  firm  and  in  addi- 
tion  had    loaned    the   firm   $3,000.     He   also    had  a 
one-third  interest  in  a  credit  against  the  firm  of  $12,000, 
the  other  two-thirds  belonging  to  his  brother,  L.  a! 
Ehrenbahn.     The  firm  held  property  whose  book  value 
was  approximately  $2(50,000.     Immediately  after  the 
death    of   James    Ehrenbahn    the    surviving   partners 
caused  to  be  written  off  to  profit  and  loss  accounts  and 
bills  receivable  alleged  to  be  uncollectible  amounting  to 
$110,000,  leaving  a  net  book  value  of  the  property  of 
the  firm  of  approximately  $1.50,000.     L.  A.  Ehrenbahn 
was  acting  not  only  for  himself  but  also  for  the  estate 
of  his  brother,  of  which  he  had  been  appointed  adminis- 
trator.    The  surviving  partners  made  no  attempt  to 
close  the  affairs  of  the  firm,  but  continued  in  business 
and  made  large  profits,  «)f  which  they  rendered  no  ac- 
counting.    In  continuing  the  business  they  used   up 
money  and  property  belonging  to  the  estate  of  James 
Ehrenbahn. 

About  October  1, 1898,  the  surviving  partners  agreed 
to  form  a  corporation,  lease  to  it  the  plant  and  real 
estate  of  the  co-partnership  and  sell  to  it  on  credit,  the 
terms  being  indefinite,  the  personal  property,  accoimts 
and  bills  receivable  in  the  hands  of  the  surviving 
partners.  Tlic  corporation  took  over  the  inventory  of 
finished  products  at  an  appraised  value  to  be  paid  for 
out  of  money  receive»l  from  the  sale  of  implements  on 
hand.  The  organization  of  the  corporation  was  in  1898 
and  its  operations  began  the  same  year,  but  no  stock  was 
issued  until  lOO.'J. 

A   peculiarity  of  the  business  thus  transferred  was 
that   j.irge  amounts  of  agricultural    iiM|)lements  were 


MANIPULATION  BY  STOCKHOLDERS  447 


sold  "on  consignment"  to  agents  who  had  the  privilege 
of  cither  returning  the  goods  or  of  paying  for  them. 
Tilt'  corporation  now  began  to  deal  with  these  agents, 
sciit  tliem  new  stocks  of  goods  arid  allowed  them  without 
protest  to  return  the  goods  which  had  been  sent  them 
on  consignment  by  the  partnership;  thus  the  accounts 
atid  bills  receivable  of  the  partnership  were  rendered 
worthless  and  their  place  was  taken  by  accounts  re- 
ceivable of  the  corporation.  Furthermore,  the  corpo- 
ration used  no  diligence  in  collecting  the  accoimts  re- 
ceivable of  the  partnership  that  were  left  outstanding. 

In  ^larch,  1903,  L.  A.  Ehrenbahn  for  himself,  and 
assuming  to  act  as  administrator  of  his  brother's  estate, 
delivered  a  new  lease  to  the  corporation  of  the  land  and 
Idiildings  belonging  to  the  partnership  at  the  excessively 
low  rate  of  $1 ,000  a  year.  In  the  same  year  the  partner- 
ship made  a  final  sale  to  the  corporation  of  the  personal 
property  for  $20,000,  although  this  same  property  had 
hecn  valued  in  1808  at  $50,000.  Between  1898  and 
VMY.i  the  corporation  paid  nothing  f(»r  the  property  or 
for  its  use.  Beginning  in  1904  the  corporaticm  paid 
aimual  10  per  cent  dividends  on  a  capitalization  of 
Jj'lOO.OOO.  The  record  does  not  show  what  dividends 
were  paid  between  1898  and  1904.  When  the  case 
came  into  court  nn  complaint  of  the  heirs  of  James 
Khrenbahn  <lecision  in  substance  was  that  the  corpora- 
tion should  be  com|K'lled  to  ])iiy  a  price  to  be  fixetl  after 
investigation  by  a  master  for  the  personal  property  and 
real  estate.  It  was  ad  judged,  however,  in  the  case  of 
accounts  and  bills  receivable,  that  no  legal  liability  lay 
a;.sii>»st  the  corporation. 

There  can  be  no  (juestion.  judging  from  the  facts 
as  presented  to  the  court,  that  large  sums  had  been  de- 
liberately withheld  from  the  p-irtncrsbip  and  transferred 


448 


coRroi;  vTioN  fixn  ^in  ce 


to  the  CDrporution  by  the  inunipulation  of  the  aecoimts 
and  hills  receiviihle.  Vet  this  iimnipulation  eould  be 
carried  on  so  easily  by  the  corporation  that  it  was  im- 
possible to  prove  fraud  or  ba<l  faith. 

2.>1 .  licnu'dk'H  for  man ipiilat ion. —The  examples  that 
have  been  cited  in  these  three  chapters  on  corporate 
manipulation  seem  to  the  writer  not  only  interesting 
but  highly  instructive.  It  is  an  unpleasant  duty  to 
record  instance  after  instance  of  cunning  rascality, 
cs|)ecially  when  the  record  to  be  truthful  must  set  forth 
at  least  temporary  sjiccesses  on  the  part  of  the  rascals. 
As  was  said  at  the  bejjfinnin'f,  the  swindlin«j  operations 
are  for  the  most  |)art  in  a  field  which  the  law  does  not 
reach  and  their  perpetrators  are  seldom  given  the  legal 
punishment  to  which  they  are  justly  entitled.  For- 
tunately the  ptinishmcnt  of  social  opprobriuuj  and  loss 
of  business  standing  is  generally  visited  upon  them. 

The  j)urpose  of  tlicse  chapters  will  have  been  secured 
if  they  serve  to  warn  owners  of  cr)rporate  securities  of 
the  facilities  which  the  corporate  form  affords  for  graft 
and  dishonesty.  The  writer  desires  to  reiterate  that 
instances  of  the  kind  that  have  been  narrated  are  rare 
compared  with  the  vast  amount  of  entirely  lumorable  and 
legitimate  business  transacted  under  the  corporate  form 
of  business  organization.  Nevertheless  they  are  fre- 
<|uent  enough  to  demand  attention  and,  so  f:ir  as  pos- 
sible, prevention. 

One  preventive  is  for  security-holders  to  insist  on 
complete  and  absolute  [)ublicity  as  to  the  nffairs  of  their 
organi/ations. 

Another  prtvt  iilive  is  for  them  to  attend  stockholders' 
meetings  and  take  an  active  interest  in  all  that  goes  on 
in  the  corporation. 

A  third  preventive  is  to  see  tf)  it  that  under  the  cumii- 


MANirULATION  BY  STOCKHOLDERS 


449 


lative  system  of  voting  every  stockholder  gets  a  chance 
to  be  represented. 

A  fourth  preventive  is  to  insert  explicit  provisions 
iti  the  corporate  by-laws  as  to  salaries  of  officers,  amount 
of  indebtedness  to  be  incurred,  amount  of  surplus  to  be 
set  aside  each  year,  and  so  on. 

The  best  preventive  of  all,  however — without  which 
all  the  other  measures  will  prove  of  small  avail — is  for 
the  security-holder  to  investigate  with  the  greatest  care 
tlie  reputation  of  all  the  officers  and  directors  of  the 
corporation. 


r— VI- 


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lANSI  and  ISO  TEST  CHART  No    2) 


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12.8 


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fl 


CHAPTER  XXIX 

INSOLVENCY  AND  RECEIVERSHIPS 

252.  Ttt'o  Ujpes  of  insolvenci/.— The  causes  of  in- 
solvency have  perhaps  been  sufficiently  indicated  in 
connection  with  the  subject  of  management  of  capital 
funds  and  of  earnings.  At  any  rate,  they  may  be 
inferred  to  be  the  reverse  of  the  principles  of  sound 
corporate  finance,  which  were  there  laid  down.  It  will 
do  no  harm,  however,  to  recapitulate  briefly  the  prinicpal 
causes.  A  great  many  business  men,  even  the  managers 
of  large  corporations,  are  evidently  not  fully  alive  to 
the  dangers  which  threaten  any  corporation. 

It  is  well  to  distinguish  between  two  types  of  in- 
solvency. The  distinction  for  our  purpose  is  important, 
although  in  law  and  in  ordinary  business  language  it  has 
not  been  clearly  kept  in  view.  We  may  call  one  type 
"true"  and  the  other  "legal"  insolvency.  True  insol- 
vency exists  where  the  value  of  an  individual's,  firm's  or 
corporation's  assets  is  less  than  its  total  debts.  This, 
by  the  way,  is  substantially  the  definition  given  in) 
the  National  Bankruptcy  Act,  but  it  is  declared  by 
eminent  legal  authorities  to  be  a  definition  without' 
precedent  in  the  law.  Such  insolvency  may  or  may  not 
lead  to  failure.  Certainly  if  failure  is  not  to  follow 
there  must  be  an  improvement  in  the  condition  of  the 
business.  It  frequently  happens,  however,  where  debts 
are  not  immediately  payable,  that  a  concern  insolvent 
in  this  sense  will  manage  to  pull  out  of  its  difficulties 
and  meet  its  obligations  when  they  finally  mature. 

4ffO 


INSOLVENCY  AND  RECEIVERSHIPS 


451 


Legal  insolvency  exists  when  a  concern's  cash  assets 
are  insufficient  to  meet  its  liabilities  as  they  fall  due.  It 
may  well  be,  and  frequently  is,  true  in  such  a  case  that 
the  total  assets  would  far  overbalance  the  total  obliga- 
tions. As  obligations  are  almost  uniformly  payable  in 
cash  and  cash  only,  however,  it  really  makes  no  differ- 
ence how  great  the  value  of  the  firm's  unsalable  assets 
may  be.  Legal  insolvency  almost  of  necessity  leads 
immediately  to  suspension  or,  in  the  case  of  small 
concerns,  to  bankruptcy.  The  only  escape  would  be 
a  compromise  of  some  kind  accepted  by  creditors. 

253.  Causes  of  true  insolvency. — True  insolvency 
may  exist  from  the  very  beginning  of  corporate 
existence,  although  not  usually  without  bad  faith  on  the 
part  of  the  incorporators.  It  is  possible,  however,  that 
the  value  of  a  corporation's  assets  at  the  beginning  may 
be  honestly  over-estimated,  that  the  corporation  may 
borrow  an  undue  amount  of  money  secured  by  such 
assets,  and  that  the  money  thus  obtained  may  be  fool- 
islily  expended.  In  such  a  case,  unless  a  marked  rise 
in  the  value  of  the  assets  takes  place,  the  corporation 
may  be  said  never  to  have  been  truly  solvent.  It  is  only 
a  question  of  time  until  the  inevitable  failure  arrives. 

A  second  cause  of  true  insolvency  may  be  a  great  and 
perhaps  unavoidable  decline  in  the  value  of  a  corpora- 
tion's assets.  If,  for  instance,  a  cyclone  demolishes  the 
property  of  a  corporation  that  does  not  carry  insurance 
ai^^ainst  s.ich  a  calamity,  insolvency  will  necessarily  be 
tlie  result.  The  fall  in  the  value  of  the  assets  may  be 
(hie  simply  to  ordinary  causes,  which  are  not  offset  by  a 
•lepreciation  reserve.  Any  one  of  a  hundred  otheH 
events,  wb'-h  will  occur  to  every  reader,  may  reduce  the 
value  of  assets  below  obligations.  It  may  be  stated, 
however,  that  a  conservatively  managed  corporation  is 


yj 

1 

i- 

.  i< 

i '; 

f  ,1 

452 


CORPORATION  FINANCE 


i'K 


not  likely  to  suffer  in  this  way.  The  principles  of  in- 
surance and  of  depreciation  are  now  so  widely  applied 
that  a  high  degree  of  protection  is  afforded. 

The  third  cause  of  true  insolvency,  especially  with 
trading  companies,  is  bad  management  in  buying  and 
selling  goods.  The  lack  of  a  proper  system  of  cost  ac- 
counting may  lead  corporation  managers  to  a  long- 
continued  course  of  selling  below  cost.  The  fact  that 
such  a  course  has  been  followed  may  not  become  entirely 
apparent  for  a  number  of  years;  then  it  is  found  that 
the  corporation  has  been  gradually  consuming  its  capi- 
tal funds  in  order  to  pay  running  expenses. 

The  complexity  of  modern  business  is  such  that  fre- 
quently an  accurate  and  searching  analysis  carried  on 
at  considerable  expense  is  necessary  in  order  to  deter- 
mine whether  a  business  is  being  carried  on  at  a  profit 
or  not.  Many  a  concern  has  seen  its  sales  growing, 
its  gross  profits  swelling  and  apparently  its  surplus 
increasing,  while  at  the  same  time,  owing  to  lack  of  care 
to  maintain  its  fixed  assets  in  good  condition  and  to  keep 
up  its  established  trade,  it  has  in  reality  been  moving 
rapidly  into  insolvency.  An  anecdote  is  told  of  a  large 
wholesale  dealer  in  men's  clothing  who  was  selling 
quantities  of  goods  at  prices  which  expert  accoimtants 
found  to  be  considerably  below  cost,  including  in  cost 
all  the  selling  and  administrative  expenses.  The  ac- 
countant approached  the  manager  of  the  company  and 
asked  him  how  he  could  afford  to  carry  on  his  business. 
"Ah,"  was  the  naive  reply,  "you  see  our  transactions 
are  on  so  much  larger  a  scale  than  those  of  any  of  our 
competitors."  It  seems  needless  to  add  that  this  par- 
ticular concern  did  not  long  keep  out  of  the  bankruptcy 
court. 

The  fourth  cause  of  true  insolvency  is  actual  fraud 


INSOLVENCY  AND  RECEIVERSHIPS 


453 


or  theft,  a  cause  which  need  not  be  here  discussed. 
254.  One  cause  of  legal  insolvency — "lack  of  capital." 
—As  to  the  causes  of  legal  insolvency,  we  have  a  val- 
uable mass  of  information  collected  by  the  two  great 
mercantile  agencies,  Bradstreet's  and  Dun's.  The  Brad- 
street  Company  summarize  their  judgments  as  to  the 
prime  causes  of  all  the  business  failures  that  occurred 
in  the  United  States  during  the  four  years  preceding 
the  crisis  of  1907,  in  the  following  table: 


Ccmte*  of  Failure, 


Incompetence  ... 
Inexperience   .... 
Lack  of  capital. .. 
I'nwise  credits  . . , 
Kiiltires  of  others. 
Il'.travagance   ... 

Vcjrlect , 

Conipetition , 

SiHfific  conditions 

Speculation   , 

Fraud  


Percentage*. 


190T 


23.6 
4.9 

37.1 
2.3 
1.4 
.9 
2.5 
1.2 

163 
.T 

lO.l 


1906 


22.3 
4.9 

35.9 
2.6 
2.0 
1.0 
2.3 
1.0 

17.3 
.8 

10.0 


1905 


24.4 
4.8 

33.4 
3.5 
2.2 
1.1 
2.9 
1.5 

163 

.7 

9.2 


1904 


23.1 
5.1 

32.3 
3.4 
2.5 
.8 
3.1 
13 

19.1 

.8 

8.6 


The  reader  will  notice  that  "lack  of  capital"  heads  the 
list  and  that  personal  incompetence  comes  second.  Un- 
fortunately no  distinction  is  made  between  lack  of  per- 
manent capital  and  lack  of  working  capital.  It  seems 
safe  to  say,  however,  that  lack  of  permanent  capital  does 
not  usually  in  itself  lead  to  insolvency;  most  businesses 
may  be  automatically  adjusted  to  any  reasonable  amount 
of  capital.  The  difficulty  comes  rather  in  the  form  in 
which  the  capital  funds  are  invested,  particularly  in  sac- 
rificing quick  in  order  to  build  up  fixed  assets. 

To  make  this  statement  concrete  let  us  examine  the 
Wall  Street  Journal's  analysis  of  two  typical  instances 
of  financial  difficulty.  In  February,  1909,  the  Ameri- 
can Ice  Company  was  reported  to  be  facing  insolvency 


1 1 


i 


454 


CORPORATION  FINANCE 


1 


and  reorganization  and  the  Journal  commented  as  fol- 
lows: 

The  annual  report  just  submitted  shows  that  the  floating 
debt,  about  $650,000  a  year  ago,  has  now  reached  the  threaten 
ing  proportions  of  something  like  $1,250,000.  Herein  lies  the 
whole  trouble  with  the  American  Ice  Company.  The  concern 
transacted  a  gross  business  during  the  year  ended  October  31 
of  $8,120,000,  and  it  is  clear  that  to  maintain  this  volume  of 
business  ample  liquid  capital  is  essential.  The  report  evidences 
the  need  of  working  funds  in  other  ways;  it  shows  that  $72- 
728  was  expended  for  interest  on  its  floating  debt. 

Where  the  company  will  raise  money  is  a  problem.  It  is 
known  that  institutions  friendly  to  the  company  which  have 
helped  It  out  of  difficulties  in  the  past,  have  withdrawn  further 
support.  The  company  has  Httle  credit  of  its  own  to  borrow 
on.  The  treasury  contains  several  hundred  thousand  dollars 
worth,  par  value,  of  securities  of  subsidiary  concerns,  but  these 
are  hardly  sufficient  for  collateral  for  a  loan  as  large  as  Amer- 
lean  Ice  requires. 

Evidently  the  company  was  in  danger  of  legal,  not 
true,  msolvency.  After  the  above  paragraphs  were  writ- 
ten  the  ice  company  denied  its  allegations  and  asserted 
that  It  was  not  in  serious  need  of  financial  assistance. 
Nevertheless  the  quotation  indicates  clearly  enough 
where  a  trained  financial  writer  looks  for  symptoms 
of  weakness. 

255.  The  case  of  the  Detroit,  Toledo  and  Ironton 
Railway  Compamj.-The  paragraphs  that  follow  con- 
stitute an  attempt  to  explain  the  failure  of  the  Detroit, 
Toledo  and  Ironton  Railway  Company. 

The  company  in  question,  a  reorganization  of  the  old  Detroit 
Southern,  began  business  in  the  earlv  part  of  1905.  When  the 
management  of  the  property  again  passed  into  the  hands  of 
the  court  this  year,  its  new  career  had  lasted  about  two  and  a 


INSOLVENCY  AND  RPX'EIVERSHIPS 


455 


half  years,  during  no  part  of  which  had  it  succeeded  in  earning 
the  fixed  charges  wliich  tlie  capitalization  of  the  reorganization 
j)laii  had  fastened  upon  it.  In  the  first  full  fiscal  year  of  its 
operation  as  an  extended  system,  the  deficit  after  payment  of 
interest  charges  and  taxes  amounted  to  $270,000 ;  in  the  second 
fiscal  year  which  ended  June  30th  last,  the  deficit  reached  the 
.sum  of  $371,000.  After  that,  presumably,  the  company  ran 
still  further  behind. 

As  to  the  question  of  working  capital,  the  Detroit,  Toledo 
&  fronton's  balance  sheet  of  June  30,  1905,  practically  the  be- 
ginning of  its  career,  shows  current  assets  of  $1,218,524  and 
current  liabilities  of  $390,194,  making  an  apparent  working 
balance  of  $828,330.  Among  these  current  assets  was  an  item, 
"due  from  reorganization  committee,  $1,050,000."  A  year 
later  this  item  had  disappeared  into  equipment  account,  and  the 
inference  is  that  it  never  was  a  part  of  true  working  capital.  In 
that  case,  the  new  company  began  without  any  working  capi- 
tal, but  with  an  actual  funded  debt  of  about  $200,000. 

If  President  Zimmerman's  theory  that  the  receivership  is  pri- 
marily attributable  to  the  clause  of  the  Hepburn  law  which  for- 
bade the  company  to  proceed  with  its  Kentucky  coal  mining 
project  is  true,  the  Detroit,  Toledo  &  Ironton  as  it  exists  was 
not  a  success  to  begin  with.  That  is,  it  did  not  have  and  could 
not  obtain  a  current  revenue  sufficient  to  carry  its  own  obliga- 
tions, aside  from  the  cost  of  the  Ohio  River  Bridge  and  Ken- 
tucky extension,  and  could  only  become  a  self-sustaining  prop- 
erty by  tapping  an  entirely  new  and  rather  distant  source  of 
traffic.  Such  a  development  naturally  could  not  take  place 
ixcept  through  the  investment  of  much  additional  capital  and 
the  completion  of  works  bound  to  take  a  year  or  two  in  con- 
struction. Meanwhile  the  company  was  exposed  in  a  perilous 
financial  condition  to  the  usual  danger  of  adverse  general  con- 
ditions, which  did  not  fail  to  arrive. 


4 


The  two  causes  assigned  in  this  case  are :  First,  lack 
of  earning  power  in  the  assets  sufficient  to  meet 
fixed  charges,  which  is  a  condition  of  true  insolvency; 


456 


CORPORATION  FINANCE 


and,   second,  lack   of  current   assets,   or  of  workinj? 
capital.  » 

256.  Additional    causes   of   legal   insolvency.— V^q 
have  found  in  our  study  of  financial  management  that 
It  IS  not  usually  advisable  for  a  concern  to  allow  its  ac- 
counts payable  to  exceed  70  to  80  per  cent  of  its  ac- 
counts  receivable;  that  its  bank  loans  should  be  repre- 
sented for  the  most  part  by  cash  in  the  bank;  and  that 
Its  finished  products  on  hand  should  not  be  offset  by  any 
corresponding  liability.     If  these  relations  are  not  main- 
tained, the  company  is  apt  to  sink  first  into  an  unprof- 
itable and  next  into  a  highly  dangerous  situation.     The 
concern  begins  to  lose  profits,  if  its  working  capital  is 
msufficient  to  permit  taking  full  advantage  of  all  con- 
^derable  discounts  for  the  prompt  payment  of  bills. 
Ihis  pomt  has  already  been  discussed  in  connection  with 
financial  management.     It  is  obvious  that  as  working 
capital  decreases  the  corporation  manager  is  driven  to 
depend  more  and  more  upon  his  current  sales  and  ac- 
counts receivable  for  funds  with  which  to  pay  his  bills 
If  for  any  reason  his  sales  fall  off  sharply  or  his  debtors 
fail  to  pay  promptly,  he  will  be  unable  to  meet  his  own 
obligations  promptly.     Unless  he  can  secure  extensions 
or  arrange  for  loans  from  some  other  source  failure  is 
mevitable. 

Let  us  give  attention  again— for  this  is  an  important 
point— to  the  fact  that  a  concern  may  fail  in  this  manner 
although  Its  assets  may  be  thoroughly  sound  and  far  in 
excess  of  obligations,  its  business  large  and  growing, 
and  its  profits  great.  Carelessness  or  lack  of  apprecia- 
tion of  the  necessity  of  keeping  up  working  capital  may 
thus  be  the  sole  cause  of  legal  insolvency.  As  to  the 
statement  that  the  trouble  with  many  concerns  is  "lack 
of  capital."  our  analysis  has  indicated  that  the  proper 


INSOLVENCY  AND  RECEIVERSHIPS 


457 


wording  of  this  phrase  in  most  cases  would  be  "lack  of 
woriving  capital." 

^V.  slightly  diflFerent  cause  of  legal  insolvency  arises 
when  a  corporation,  in  order  to  pay  dividends,  unduly 
increases  its  quick  obligations.  It  may  well  be  in  such 
a  case  that  the  dividends  have  been  earned  and  are  prop- 
erly due  to  the  stockholders.  If  the  profits  that  are  to 
be  used  for  dividends,  however,  have  been  put  back  into 
the  property  or  into  any  sort  of  permanent  invest- 
ment, the  payment  of  the  dividends  will  involve  borrow- 
ing money.  Among  conservative  financiers  this  is 
universally  regarded  as  a  dangerous  practice.  Divi- 
dends ought  to  be  provided  for  in  advance  by  so  large 
an  accumulation  of  cash  that  their  payment  will  not 
unduly  reduce,  even  temporarily,  the  corporation's 
working  capital. 

A  third  frequent  cause  of  legal  insolvency  is  inability 
to  renew  medium  term  notes  or  refund  long-time  obliga- 
tions when  due.  This  siuation  may  not  be  the  fault,  so 
much  as  the  misfortune,  of  the  corporation.  The  ob- 
ligation may  fall  due  during  the  height  of  a  crisis  when 
borrowing  of  money  on  any  terms  is  next  to  impossible. 
It  may  have  been  entirely  proper  to  issue  the  obligations 
in  the  first  place ;  the  as  >ets  may  be  far  more  than  suffi- 
cient in  value  to  cover  them:  and  yet  the  actual  cash  to 
meet  them  may  not  be  forthcoming.  We  shall  have  oc- 
casion in  the  following  pages  to  discuss  a  recent  case  of 
failure  and  reorganization  which  falls  within  this  class. 

257.  Tivo  methods  of  handling  insolvency — Bank- 
ruptcy and  dissolution. — There  is  so  much  confusion — 
not  only  in  the  public  mind,  but  even  among  lawyers — 
as  to  the  exact  nature  of  the  remedy  that  should  be  ap- 
plied when  a  corporation  gets  into  financial  difficulties, 
that  it  seems  proper  to  preface  our  study  of  corporate 


458 


CORPORATION  FINANCE 


V- 


reorganization  by  a  brief  survey  of  the  legal  aspects 
ot  insolvency,  receivership  and  bankruptcy.  Much  of 
what  IS  said  in  tiiis  chapter  will  apply  to  individual 
proprietorships  and  to  partnerships,  as  well  as  to  cor- 
porations.  Additional  information  on  the  topics  here 
briefly  treated  will  be  found  in  the  volume  on  Com- 
mercial Law. 

The  reader  is  probably  alreadv  aware  that  the  con- 
stitution of  the  United  States  confers  upon  Congress  the 
sole  authority  to  establish  a  uniform  law  as  to  bank- 
ruptcy  procedure  for  the  whole  country,  and  that  the 
atest  expression  of  this  authority  is  found  in  the  Na- 
tional Bankruptcy  Act  of  1898.     Bankruptcy  may  be 
either  voluntary  or  involuntary.     It  may  be  'asked  for 
by  an  insolvent  individual  or  partnership  in  order  to 
obtain  a  discharge  from  his  or  its  debts;  or  it  may  be 
asked  for  by  cretlitors  whose  claims  are  unsatisfied  in 
order  to  obtain  an  equitable  division  of  the  property  of 
he  oankrupt.     The  Bankruptcy  Act,  as  amended  in 
IJIO,  provides  that  all  corporations,  except  municipal, 
railroad,  insurance  and  banking,  may  file  voluntary 
petitions  m  bankruptcy;  involuntary  petitions  may  be 
filed  against  all  "moneyed,  business  and  commercial" 
corporations  except  municipal,  railroad,  insurance  and 
banking  corporations.     It  will  be  noticed  that  charitable 
and  religious  corporations  are  not  prohibited  from  filing 
voluntary  petitions.     The  presumption  is  that  they  may 
do  so.     As  a  matter  of  fact,  it  is  seldom  to  the  interest 
either  of  stockholders  or  of  creditors  to  force  a  corpora- 
tion into  bankruptcy.     Indeed,  the  chief  reason  that 
may  lead  to  such  drastic  action  is  the  desire  of  unsecured 
creditors  to  prevent  secret  deals  and  transfers  of  the 
corporation's  assets  and  to  expose  any  past  irregularities 
m  the  conduct  of  the  corporation.     Bankruptcy  is  espe- 


INSOLVEiNCY  AND  RECEIVERSHIPS 


459 


cially  valuable  at  times  as  a  means  of  making  invalid 
liens  or  judgments  that  have  been  secured  by  favored 
creditors  within  four  months  of  the  period  of  bank- 
ruptcy. 

A  second  method  of  handling  the  affairs  of  an  insol- 
vent corporation  is  by  a  dissolution  of  the  corporation 
and  a  distribution  of  its  assets  to  creditors  and  share- 
holders. This  method  is  even  more  infrequent  than 
bankruptcy  and  is  plainly  out  of  place  except  for  cor- 
l)()rations,  the  organization  and  good  will  of  which  are 
not  worth  saving. 

2.58.  A  third  method — Appointment  of  a  receiver. — 
A  third  method  is  the  use  of  what  is  known  in  law  as  a 
"bill  in  chancery."  The  objects  sought  to  be  obtained  by 
this  method  are,  first,  to  come  to  an  equitable  settlement 
l)etween  the  corporation  and  its  creditors,  and,  second,  to 
preserve  the  corporation's  organization  and  continue  its 
business.  The  "bill  in  chancery"  is,  in  lay  language, 
simply  a  petition  presented  to  a  court  of  equity  asking 
the  court  for  protection  and  supervision  of  the  corpora- 
tion's property  and  business  until  a  settlement  of  the 
conflicting  claims  may  be  secured.  If  the  petition  is 
granted,  the  court  at  once  appoints  an  officer  responsible 
solely  to  the  court  known  as  a  "receiver,"  whose  busi- 
ness  it  is  to  conduct  the  corporation's  affairs  until  he  is 
discharged.  The  petition  may  be  presented  by  any  one 
of  four  parties:  (a)  the  corporation  itself;  (b)  the 
stockholders;  (c)  secured  creditors;  or  (d)  unsecured 
creditors. 

A  petition  of  this  character  presented  by  a  corpora- 
tion in  its  own  name  is  unusual  and  instances  of  its  being 
granted  by  the  court  are  still  rarer.  It  is  also  somewhat 
unusual  to  find  petitions  by  stockholders  presented  and 
granted.    A  complaining  stockholder  is  usually  told  by 


■1^   r 


*r;  111 
i 


4C0 


CORPORATION  FINANCE 


the  court  that  his  proper  course,  if  he  is  dissatisfied  with 
the  management  of  the  corporation,  is  to  elect  new  di- 
rectors.     Moreover,  a  complaint  by  a  stockholder  that 
his  corporation  is  insolvent  and  should  be  placed  in  a 
receiver's  hands  is  seldom  necessary,  for  in  such  a  case 
creditors  will  be  more  than  likely  to  take  the  initiative. 
Where  the  corporation  itself  is  willing  that  a  receiver 
should  be  appointed  the  petition  is  usually  presented  by 
friendly  unsecured  creditors.     This  is,  in  fact,  the  usual 
method  of  securing  what  is  known  as  a  "friendly  re- 
ceivership."    It  is  doubtful,  however,  in  many  states, 
whether  an  unsecured  creditor  can  successfully  apply 
for  a  receivership  in  the  face  of  opposition  on  the  part 
of  a  corporation.     Secured  creditors  have  a  far  stronger 
case  and  a  petition  on  their  part  based  on  the  proved 
insolvency  or  mismanagement  of  the  corporation  is  not 
generally  denied. 

Unlike  petitions  in  bankruptcy,  bills  in  chancery  may 
be  presented  either  in  the  federal  courts  or  in  any  of  the 
state  courts  which  have  jurisdiction.     Here  is  a  frequent 
cause  of  much  confusion  and  frequently  of  conflict  be- 
tween courts.     The  legal  questions  involved  are  entirely 
too  complicated  and  technical  to  be  discussed  in  this 
chapter.     All  that  need  be  said  is  that  where  large  in- 
ter-state corporations  are  involved  the  tendency  is  grow- 
ing to  apply  to  the  federal  courts  for  relief.     One  reason 
is  that  the  judges  of  these  courts  are  especially  familiar 
with  cases  of  this  kind;  another  reason  of  still  greater 
importance  is  that  federal  judges  in  different  parts  of 
the  country  work  together  more  harmoniously  than  do 
the  judges  of  different  states. 

259.  Duties  of  a  receiver.— If  the  corporation  is  car- 
rying on  simply  a  trading  business  and  goes  into  bank- 
ruptcy, the  activities  of  the  receiver  in  bankruptcy  will 


INSOLVENCY  AND  RECEIVERSHIPS 


461 


he  comparatively  simple.  He  will  dispose  of  the  assets 
as  rapidly  as  he  can  and  will  use  the  funds  thus  obtained, 
so  far  as  they  will  go,  to  settle  with  creditors.  There 
may  be  a  considerable  waste  in  this  process,  for  the 
established  trade  and  business  connections  of  the  failed 
company  will  go  for  nothing.  Yet,  on  the  whole,  it  is 
the  quickest  and  most  certain  method  of  satisfying  the 
obligations  of  the  company,  and  it  is  usually  followed. 
Unless  the  corporation's  borrowings  have  been  far  in 
excess  of  the  value  of  its  tangible  assets,  the  obligations 
will  be  met  and  the  loss  will  all  be  borne  by  the  stock- 
holders. In  an  ordinary  bankruptcy  the  stockholders* 
interests  are  very  little  considered. 

Where  the  failed  corporation  is  a  large  manufactur- 
ing or  railroad  company  with  a  great  amount  of  fixed 
caiptal  and  a  receiver  is  appointed  by  a  court  of  equity, 
his  duties  are  entirely  different.  He  has  as  his  object 
in  ihis,  as  in  the  former  case,  the  payment  of  corporate 
obligations.  It  is  very  seldom,  however,  that  this  ob- 
ject, when  the  corporation  has  large  fixed  assets,  can  be 
attained  by  the  sale  of  these  assets.  Ordinarily  there 
is  no  one  to  buy  them  except  at  a  tremendous  sacrifice. 
It  would  evidently  be  quite  impossible  to  find  cash 
buyers  for  the  millions  of  dollars  of  property  of  any  of 
the  great  industrial  combinations  or  of  any  of  the  great 
railroads.  Therefore,  the  receiver  is  permitted  in  such 
a  case  to  go  on  with  the  business.  No  profitable  ac- 
tivities of  the  concern  are  allowed  to  cease.  It  goes  on 
manufacturing  or  transporting,  or  whatever  its  business 
may  be,  under  the  receiver's  administration,  just  as  it 
did  uader  the  administration  of  its  own  officers.  As  the 
holders  of  claims  against  the  failed  corporation  cannot 
hope  for  immediate  payment  in  cash,  a  settlement  with 
them  must  be  made  in  some  other  manner — usually 


462 


CORPORATIOx\  FINANCE 


through   a  reorganization,   a   subject   to   which   con- 
Mderable  attention  is  given  in  the  following  chapter" 
''^0    fcetver^s   powers.-The    receiver  Is    a    ve' 
powerful  ofhcal.     So  long  as  no  actual  fraud  or  obvious 
nusn..na,.ement  on  his  part  is  proven,  he  is  at  libert^^ 
to  make  such  disposition  of  the  assets  and  earnini 
under  h.s  charge  as  he  sees  fit.     He  may  use  his  no3 
altogether  for  the  benefit  of  the  creditors!  or  he    .T 
It  in  part  also  for  the  benefit  of  the  stockholders: 
he  has  the  latter  object  in  view,  he  will  naturally  do  what 
he  can  to  de  ay  a  settlement  until  a  favorable  period  ar- 
rives  and  will  thus  preserve  as  much  of  the  property  as 
possible  for  the  stockholders.  P^"perty  as 

the   stockholders-and   frequently   more   equitable  to 
every  one  concerned-to  have  a  receiver  of  their  own 
choosing  appomted.     In  recent  years  it  has  become  cus- 
tomary  for  corporations  which  are  getting  into  diffi- 
eulties  to  secure  from  the  court  the  appointment  of  what 
are  generally   known   as   "friendly"   receivers.     Fre- 
quently  the  friendly  receivers  are  officers  of  the  corpo- 
ration.     In  order  to  get  this  result   there  must   be 
collusion  between  one  or  more  of  the  creditors  and  the 
corporate  officials.     The  creditor  or  creditors  and  the  of! 
fieials  go  secretly-often  at  dead  of  night-to  some 
udge  who  /ms  jurisdiction;  the  creditor  complains  that 
us  debt  IS  unpaid  and  the  officials  confess  insolvency; 
then  the  creditor  asks  for  the  appointment  of  some  man 
previous  y  agreed  upon  to  act  as  receiver  and  the  judge 
then  and  there  duly  appoints  him.     Of  course,   the 
judge  must  be  fully  aware  of  this  scheme  and  must 
approve  It      On  account  of  the  conflicting  jurisdictions 
of  our  state  and  federal  courts,  however,  it  is  usually 
a  very  easy  matter  to  find  one  among  the  several  judges 


INSOLVENCY  AND  RECEIVERSHIPS  463 

with  the  proper  authority  who  will  do  what  is  wanted. 
It  will  not  do  to  say  off-hand  that  in  every  case  the 
appointment  of  friendly  receivers  is  absolutely  wrong, 
or  that  the  judge  who  makes  the  appointment  is  corrupt. 
As  has  been  intimated,  insolvency  sometimes  results 
from  causes  beyond  the  control  of  corporate  officials 
and  iiasty  action  on  the  part  of  receivers  would  cause 
heavy  unnecessary  loss.  We  cannot  absolutely  con- 
demn, therefore,  either  the  officials  who  request  the  ac- 
tion or  the  judge  who  complies  with  the  request.  Nev- 
ertheless, the  transaction,  being  secret  and  more  or  less 
irregular,  seldom  reflects  credit  on  any  one  concerned. 

Since  the  receiver,  however  he  may  be  appointed,  is  a 
court  officer,  his  expenses  are  court  expenses  and  until 
paid  constitute  a  lien  on  the  corporate  assets  that  goes 
ahead  of  all  other  claims.  Receivers'  certificates  may  be 
issued  in  order  to  secure  funds  for  practically  any  pur- 
pose that  the  receiver  deems  proper.  The  funds  may  be 
used  to  purchase  new  supplies  or  equipment  or  to  im- 
prove and  extend  the  property. 

261.  Business  failures  in  Canada.— The  following 
statistics  of  Bradstreet's  shows  the  record  of  failures  in 
Canada  during  1911  and  1912.  Considering  the  large 
number  of  companies  in  operation  and  their  immense 
capitalization  in  the  aggregate,  the  list  is  small: 

Fiiilures                Number  Assets  I.inbilitiM 

•I lie  to               1912     1911  1912  1911  19U'            1911 

ImmniH-tpnce   ....    21t     226  $1,12I.:j>h  ijl,3l7,77l  $  -\HI,',,3J9  a  2.471  "99 

Moxprrience  .              67        41  2()l.7fil  93,032  m.4<.H         200.851 

c.k   of   capital..    660      691  2,1Hi,(m  2.930.8.i4  .»,fi«0.6fi8      6.249.820 

ii«ise    credits...      17        12  148,.Wi  (i2S.W  201.714         lS0Ji44 

nliircs  of  otiiers.       12        16  77.fWi7  117,12,5  iUi^m          188,023 

Kvlnivagance  ....       II         12  29,160  308,000  (JS/jIO          417  900 

,V''-'''''"L •*«        •'«  »".87!  IH3.(.'10  •.m:m         3.32,'793 

<"t..  petition     13        1:.  39,.W8  33.699  78.958            74  150 

NTciflc  conditions.     168      .'01  6.W.0I9  780,501  1,081.139       1J14;687 

Speculation   6        13  2;i.800  123.600  .W.600          406,486 

'^""^     ■__!!!  __L^  _J1W.«<«  W»,8HS  1,271.129       1300,757 

'''«'*"'    >319  1.401  $5,61 1,6T4  W.420331  $123iI!3M  $13,087,009 


464 


CORPORATION  FINANCE 


I 


* 


k^^^ 


Nineteen  hundred  and  twelve  was  the  most  favorable 
m  five  years  in  Canada,  both  as  regards  failures  and  lia- 
bilities, and  there  individuals  were  charged  with  respon- 
sibility  for  85.3  per  cent  of  all  failures.    Lack  of  capital 
IS  the  Dominion's  besetting  business  trouble,  with  503 
per  cent  of  all  failures  charged  to  it,  as  against  16.3  per 
cent  due  to  incompetence,  6.7  per  cent  resulting  from 
fraud,  5.1  per  cent  produced  by  inexperience,  and  4  3 
per  cent  attributed  to  neglect;  specific  conditions,  fraud, 
speculation,  extravagance  and  competition  were  less  in 
their  effects  than  in  1911,  while  the  other  personal  causes 
were  more  hurtful.     Specific  conditions  were  credited 
with  12.8  per  cent  of  all  failures,  as  against  14.6  per  cent 
in  1911.    As  regards  liabilities,  lack  of  capital,  with  45.8 
per  cent  charged  thereto,  compares  with  47.8  per  cent 
in  1911,  and  specific  conditions  were  also  less  hurtful; 
but  incompetence,  with  22.8  per  cent  in  1912,  as  against 
18.9  per  cent  in  1911,  was  more  hurtful,  as  was  fraud, 
with  10.3  per  cent  in  1912,  against  9.9  per  cent  in' 
1911,  and  inexperience,  with  8.5  per  cent  in  1912  and 
1.5  per  cent  in  1911. 

Fortunately,  large  corporation  breakdowns  are  infre- 
quent  in  Canada,  with  the  exception,  perhaps,  of  indus- 
trial consolidations,  the  experience  of  many  of  which  has 
not  been  altogether  happy.  Disaster  is  sometimes  met, 
as  in  the  United  States,  by  receiverships  and  later  reor- 
ganization. Frequently,  as  we  have  already  seen,  bond 
and  shareholders  of  companies  which  have  met  trouble 
are  called  together  to  face  matters,  to  have  their  hold- 
ings "cut"  and  to  reorganize. 

An  example  of  receivership  may  be  cited.  In  August, 
1913,  at  a  meeting  of  the  directors  of  the  Canada  Iron 
Corporation.  Limited,  it  was  decided  to  apply  to  the 
courts  for  the  appointment  of  a  receiver.    The  object 


INSOLVENCY  AND  RECEIVERSHIPS  465 

was  to  obtain  a  reduction  of  fixed  charges,  which  was 
taken  to  mean  that  a  financial  reconstruction  would  be 
effected,  in  which  the  bondholders  would  be  asked  to 
accept  stock  in  lieu  of  their  secured  lien.  The  bonds  are 
held  in  England  and  listed  on  the  London  Stock  Ex- 
change. The  first-mortgage  issue  was  £600,000  of  six 
per  cents,  but  in  addition  there  was  a  "consolidated"  is- 
sue of  $1,718,000  not  listed.  There  was  $2,909,000  of 
preferred  stock  outstanding  and  $4,832,000  of  common. 
Xo  dividends  had  been  paid. 

The  dumping  of  United  States  pig  iron  into  Canada 
was  alleged  to  have  seriously  hurt  the  company's  busi- 
ness in  1911  and  the  first  half  of  1912,  but  the  last  re- 
port stated  that  conditions  during  the  latter  half  of  1912 
and  the  opening  of  1913  were  better.  In  addition  to 
mines  and  furnaces,  the  company  owned  six  foundries 
for  production  of  carwheels,  pipes  and  castings.  The 
directors  complained  that  the  abolition  of  the  Canadian 
piff  iron  bounty  left  them  at  the  mercy  of  United  States 
(lumping. 

A  receiver  was  appointed  and  carried  on  the  business 
of  the  company  pending  reorganization.  While  the  ap- 
plication for  the  receivership  was  voluntary  on  the  part 
of  the  company,  it  was  understood  to  have  been  made 
on  the  instance  of  the  second-mortgage  bondholders, 
whose  interest  instalment  due  had  not  been  paid,  and 
that  the  bondholders  would  have  a  substantial  measure 
of  control  of  the  company  under  the  proposed  reorgani- 
zation. 


d   1 


r— VI— 30 


li 


CHAPTER  XXX 

PRINCIPLES  OP  REORGANIZATION 

262   Season,  for  reorganizaUon—There  are  tw 
general  classes  of  reorganization-  first  ff. 

necessary  as  the  result  of  insdrnev  "  'co^rthl:  t.*^ 

->:^h  apply  in  all  kinrf-^rniXr'  ^""^'^'^ 
Ihe  reasons  for  reorganization  in  lieu  of  «  .™„i 
sale  of  property  have  already  been  all"  d«l  to      I       I 
to  make  them  plain,  however,  we  shol.id  ^i! etheml: 

.nto  a^oun?     jjf^  ""-P^ation  is  one  factor  to  take 
ThT'tock  !'      "'!  ""^  "'  •"""=  "-"rtKages  on  its  lin^. 

ow„am:;'i:;-„--^-^-„.^. 

466 


PRINCIPLES  OF  REORGANIZATION  467 

oiitstanding  mortgage  bonds  based  on  each  of  the  branch 
lines  mortgage  bonds  based  on  the  terminals  and  real 
estate  holdmgs.  and  very  likely,  in  addition,  a  general 
mortgage  bond  issue  to  cover  whatever  property  is  left. 
Then  there  will  probably  be  preferred  and  common 
stock  and  short-tmie  claims,  including  accounts  payable 
accrued  wages  and  bank  loans      Such  a  group  of  cor-' 
porate  relationships  and  obligations  may  be  taken  as 
t}  Ileal.     It  IS.  m  fact,  not  half  so  complex  as  the  finan- 
cial organization  of  many  large  raUroad  and  industrial 
companies. 

fin  ^r'^^T*  *.°  ^^''  complicated  financial  scheme  we 
find  the  railroad  property  to  be  practically,  for  operat- 
ing purposes,  an  indivisible  unit.     The  word  "indi- 
visible,   as  here  used,  does  not  mean,  of  course,  that  the 
property  is  actually  physically  merged  into  one.     It 
^^ould  be  possible  for  the  branch  line  bondholders  to 
mark  out  and  segregate  their  property  and  take  it  for 
hemselves;  for  the  terminal  bondholders  to  do  the  same; 
or  the  mam  line  bondholders  to  do  the  same;  and  so  on. 
It  IS  indivisible,  however,  in  the  sense  that  a  division  of 
«ie  property  would  destroy  most,  if  not  all,  of  its  value. 
11ns  statement  applies  only  to  a  well-constructed,  uni- 
fied railroad  system.     If  any  part  of  the  system  is  su- 
perfluous. It  may  be  lopped  off  and  taken  by  its  own 
bondholders.     This,  for  instance,  was  the  case  with  the 
M.   Louis  and   San   Francisco  Railroad,   which  was 
o^Mied  by  the  Atchison,  Topeka  and  Santa  Fe.  up  to 
l.e  bankruptcy  of  the  latter  road  in  1898.  and  was  then 
aken  over  by  the  St.  Louis  and  San  Francisco  bond- 
holders.     The  same  thing  was  true  of  the  Oregon  Short 
Line   which  was  temporarily  cut  off  from  the  Union 
I  aeific  system  m  the  bankniptcv  of  189.3. 
Assuming  that  a  failed  corporation  possesses  prop- 


m 


m 


468 


CORPORATION  FINANCE 


Mi 


erty  which  is  commercially  indivisible,  the  question  that 
arises  in  case  of  bankruptcy  is,  What  arrangement  can 
be  made  to  prevent  the  property  from  being  split  up 
into  segments  by  the  conflicting  claims  of  the  various 
security-holders  ?  How  can  it  be  held  together,  put  back 
on  its  feet  and  restored  to  its  rightful  position  as  a 
valuable  profit-making  business?  Every  bondholder, 
as  well  as  every  stockholder,  is  keenly  interested  in  find- 
ing the  right  answer.  The  value  of  any  bond,  as  has 
already  been  shown,  depends  in  large  part  on  the  earn- 
ing power  and  prosperity  of  the  issuing  corporation. 

263.  The  formation  of  committees. — In  the  process 
of  getting  an  answer  the  first  step  is  to  ascertain  as 
nearly  as  possible  the  exact  status  of  each  of  the  cor- 
poration's obligations.  Usually  this  task  is  left  to  the 
receivers  or  to  such  persons  as  are  selected  to  act  as  a 
reorganization  committee.  Each  class  of  bondholders 
chooses  representatives  whose  duty  it  is  to  represent  the 
interests  of  that  particular  class.  These  representatives 
are  usually  called  a  committee  and  are  selected  in  va- 
rious ways.  Sometimes  a  meeting  of  the  bondholders  of 
one  class  is  called  and  the  members  of  the  committee  are 
elected.  Sometimes  banking  houses  which  have  under- 
written one  or  more  of  the  bond  issues  come  forward 
and  offer  to  serve  on  reorganization  committees.  Gen- 
erally these  members  of  the  committee  are  self-chosen, 
and  are  of  such  character  and  standing  that  they  readily 
secure  the  support  of  their  fellow  bondholders.  Shortly 
after  the  breakdown  of  a  big  corporation  it  is  quite 
customary  for  one  of  the  heavy  bondholders  of  each 
class  to  send  a  circular  letter  to  the  other  bondholders 
of  that  class  stating  that  they  should  be  represented  in 
the  pending  negotiations  and  asking  that  they  place 
their  interests  in  his  hands.     Usuallv  he  states  in  the 


PRINCIPLES  OF  REORGANIZATION 


469 


circular  that  his  only  interest  in  the  matter  is  to  secure 
tlie  rights  of  the  persons  to  whom  he  appeals  and  that 
he  M'ill  act  in  good  faith  with  that  sole  object  in  view. 
The  bondholders  signify  their  consent  by  depositing 
their  bonds  with  some  stipulated  trust  company.  If  a 
majority  of  the  bonds  of  a  given  class  are  deposited,  the 
self-appointed  representative  or  committee  is  authorized 
to  act  on  their  behalf.  We  should  bear  in  mind,  how- 
ever, that  the  committee's  authority  is  only  that  of  a 
representative.  It  cannot  bind  the  bondholders  to  any 
terms  whatever.  Whether  the  bondholders  accept  the 
plan  which  their  committee  approves  or  not  will  depend 
largely  on  their  estimate  of  the  character  and  intelli- 
gence of  the  members  of  the  committee. 

Within  a  few  days  after  an  important  insolvency  is 
announced,  there  will  usually  come  into  existence  a 
number  of  different  duly  authorized  committees,  one 
representing  the  general  mortgage  bondholders,  one  the 
bondholders  of  each  of  the  subsidiary  companies,  one 
the  debenture  bondholders,  if  there  is  such  an  issue,  and 
so  on.  Ordinarily  it  is  not  necessary  for  the  bona  fide 
first  mortgage  bondholders  to  organize.  They  are  so 
well  protected  that  they  can  afford  to  sit  quiet  while  the 
other  claimants  fight  it  out.  Usually  also  the  stock- 
holders do  not  organize.  They  have  practically  no 
voice  in  the  reorganization,  anywny,  if  the  receivership 
is  unfriendly;  if  it  is  friendly  their  interests  are  already 
])rotected.  Sometimes,  however,  the  stockholders  as  a 
body,  or  the  preferred  and  common  stockholders,  each 
acting  as  a  class,  will  appoint  committees  of  their  own 
when  burdensome  assessments  seem  imminent. 

Once  the  committees  are  appointed  the  "jockeying 
for  position"  and  the  arguments  pro  and  con  as  to  the 
strength  of  each  of  the  competing  claims  on  the  corpora- 


470 


CORPORATION  FINANCE 


tion's  assets  begin.  If  many  different  claims  are  in- 
volved, it  will  probably  be  necessary  for  the  committee 
of  each  class  of  security-holders  to  appoint  a  single  rep- 
resentative and  have  these  representatives  form  a 
general  reorganization  committee.  It  is  the  duty  of 
this  committee  to  discuss  terms  of  reorganization  and 
finally  to  agree  upon  a  plan  which  may  be  submitted  to 
the  security-holders. 

264.  Why  not  foreclose.— The  reader  may  well  in- 
quire at  this  point  why  the  bondholders  as  a  whole  or 
some  class  of  bondholders  do  not  foreclose  and  sell  under 
their  mortgage  and  thus  get  enough  cash  to  meet  their 
own  claims,  or  failing  that,  bid  in  the  property  for  them- 
selves. It  may  correctly  be  suggested  in  this  connec- 
tion that  for  the  purpose  of  buying  the  property  when 
it  is  sold,  each  bond  would  be  accepted  at  its  par  value. 

This  question  has  already  been  answered  in  part  by 
the  statement  in  the  last  chapter  to  the  effect  that  it 
would  be  next  to  impossible  to  sell  a  large  corporation 
to  an  outsider  for  cash,  because  the  amount  involved  is 
too  large.  Besides,  an  outsider  who  wished  to  get  con- 
trol of  the  property  could  accomplish  his  purpose  much 
more  economically  by  buying  the  securities  of  the  failed 
corporation  at  the  low  prices  at  which  they  naturally 
sell  during  the  period  of  reorganization. 

In  answering  the  second  part  of  the  question  we  must 
consider  that  the  bondholders  whose  securities  are  close 
to  the  property  would  not  have  anything  to  gain  by  a 
sale.  Their  principal  and  interest,  presumably,  are  well 
protected  and  they  could  not  by  any  process  of  juggling 
get  more  than  principal  and  interest.  With  the  junior 
mortgage  bondholders  the  situation  is  somewhat  differ- 
ent. They  might  at  times,  if  the  reorganization  scheme 
appears  unfavorable  to  them,  have  something  to  gain 


PRINCIPLES  OF  REORGANIZATION 


471 


by  compelling  foreclosure,  and  bidding  in  the  property. 
In  this  case,  however,  they  might  be  forced  to  settle  all 
the  claims  that  rank  ahead  of  their  own  in  cash,  which 
would  ordinarily  be  too  large  an  undertaking.  How- 
ever, the  possibility  of  such  action  on  their  part  is  always 
recognized  by  the  reorganization  committee  and  their 
claims  are  in  consequence  treated  with  greater  respect 
than  they  would  otherwise  command.  The  result  is 
that  foreclosure  proceedings  are  usually  only  a  form. 
After  reorganization  plans  have  been  completed  fore- 
closure is  simply  a  method  of  transferring  the  property 
of  the  old  corporation  to  a  new  corporation. 

265.  Problems  confronting  the  reorganization  com- 
mittee. — The  reorganization  committee,  then,  once 
formed  has  a  reasonably  free  hand.  At  the  same  time 
it  must  act  with  due  circumspection  in  order  not  to 
arouse  the  hostility  of  any  powerful  body  of  security- 
holders. It  must  treat  everybody  with  apparent  jus- 
tice; it  must  reconcile  conflicting  claims  and  interests. 
The  success  of  whatever  plan  of  reorganization  it  adopts 
will  depend  upon  the  extent  to  which  the  plan  is  ac- 
cepted by  security-holders.  As  noted  above,  the  first 
and  perhaps  most  important  duty  of  the  committee, 
therefore,  is  to  form  some  working  estimate  of  the  rela- 
tive values  of  the  different  classes  of  securities. 

First,  they  must  consider  whether  there  has  been  an 
impairment  of  assets  and  earnings  suflicient  to  affect 
the  first  mortgage  bonds.  Usually  this  question  may 
he  answered  in  the  negative.  If  an  affirmative  answer 
has  to  be  given,  any  attempt  at  reorganization  might  as 
well  be  given  up,  for  nothing  can  be  done  except  to 
allow  the  first-mortgage  bondholders  to  take  whatever 
property  is  left.  Assuming  that  the  first  mortgage 
bondholders  are  still  in  an  entirely  safe  position,  the  re* 


472 


CORPORATION  FIXAxNCE 


I 


IKf 


mM 


organization  committee  next  considers  the  situation  of 
the  bondholders  secured  by  mortgages  on  outlying  or 
small  sections  of  property.     lAIortgages  of  this  nature 
on  railroads  are  usually  divisional,  terminal,  branch  line 
or  real  estate;  with  industrial  corporations  there  may  be 
mortgages  on  unessential  plants  or  property.     For  in- 
stance,  a  consolidation  may  originally  have  taken  in 
twenty  plants,  and  may  have  found  ten  of  the  plants 
so   uneconomical   that   it  has   transferred    almost   all 
their  busmess  to  the  other  ten;  or  a  merchandising  cor- 
poration may  have  gone  into  general  trucking;  or  a 
paper  mill  may  oAvn  a  great  expanse  of  forest  land,  not 
all  of  which  is  essential  to  its  business.     In  such  cases 
the  outlying  mortgage  bondholders  may  be  allowed  to 
take  their  property,  and  their  claims  may  then  be  elim- 
inated from  further  consideration.     It  may  well  be,  on 
the  other  hand,  that  the  separate  pieces  of  property  so 
mortgaged  are  highly  essential,  in  which  case  the  bond- 
holders would  be  able  to  insist  on  a  settlement  of  their 
claims  in  full.     Thus  a  railroad  could  not  well  get  along 
without  its  terminals  or  without  equipment,  and  the  re- 
organization committee  would  have  to  allow  full  value 
to  all  bonds  based  upon  such  property.    A  manufac- 
turing corporation  may  derive  its  chief  profits  indirectly 
from  its  control  of  the  sources  of  raw  materials,  in  which 
case  the  reorganization  committee  would  arrange  to  pay 
bonds  based  on  such  property  in  full,  even  if  the  prop- 
erty taken  in  itself  were  not  of  great  value.     Disputes 
are  bound  to  arise  in  connection  with  many  of  these 
claims  on  specific  pieces  of  property. 

A  railroad  branch  line,  for  instance,  may  earn  very 
little  revenue  for  itself,  according  to  the  railroad's 
method  of  figuring,  and  may  have  absolutely  no  value 
except  as  an  adjunct  to  the  failed  railroad.    Yet  it  may 


PRINCIPLES  OF  REORGANIZATION 


473 


turn  over  to  that  railroad  a  large  and  highly  profitable 
traffic.  The  bondholders  will  naturally  point  to  this 
traffic  as  justification  for  a  demand  that  their  claims  be 
paid  in  full.  The  other  interests  involved  will  point  to 
the  isolated  position  of  the  branch  line  apart  from  the 
railroad  as  sufficient  ground  for  attaching  very  little 
value  to  the  branch  line  bonds.  Usually  a  compromise 
is  necessary.  Both  parties  have  much  to  lose  and  noth- 
ing to  gain  by  a  permanent  separation  of  main  and 
branch  lines.  Each  side  will  probably  "bluff"  so  far  as 
it  dares,  and  each  will  finally  concede  something. 

The  reorganization  committee  next  takes  up  the 
claims  of  the  general  mortgage  bondholders  and  en- 
deavors to  ascertain  how  much  assets  and  earnings  are 
left  for  them  after  satisfying  prior  claims.  This  may 
or  may  not  be  a  particularly  difficult  task;  that  all  de- 
pends on  the  nature  sr  '  complexity  of  underlying 
mortgages.  The  value  •  the  general  mortgage  bonds 
will  depend  to  a  great  extent  on  the  wording  of  the 
mortgage.  It  may  cover  only  such  property  as  was  in 
existence  when  the  mortgage  was  drawn  or  may 
contain  an  "after-acquired  property"  clause.  Next  in 
order  of  consideration  are  the  debenture  bonds.  As 
these  bonds  are  chiefly  claims  on  earnings,  not  on  assets, 
the  reorganization  committee  in  estimating  their  value 
will  try  to  find  out  how  much  of  the  corporation's 
income  is  left  for  them  after  paying  prior  interest 
charges. 

Finally,  the  reorganization  committee  will  consider 
what  must  be  done  for  the  preferred  and  common  stock- 
liolders.  Sometimes  in  heavily  over-capitalized  concerns 
tile  common  stock  will  be  wiped  out  absolutely.  It  is 
more  usual,  however,  to  try  to  preserve  something  for 


474 


CORPORATION  FINANCE 


n  .1 


the  stockholders,  with  the  proviso,  usually,  that  the 
stockholders  pay  certain  cash  assessments. 

266.  Necessity  for  fa«A.— Another  factor  in  reorgan- 
ization not   previously  mentioned   is   the   current  or 
floating  debt  of  the  corporation.     This  debt  may  take 
the  form  either  of  loans  and  medium-term  notes  having 
specific  security  or  of  unsecured  obligations,  such  as 
accounts  payable.     Whether  secured  or  unsecured,  this 
floating  debt   must   be   paid   in   cash;   otherwise   the 
creditors  of  this  class  will  certainly  attach  the  assets  of 
the  corporation  and  effectually  prevent  the  success  of 
reorganization.     The  only  path  of  escape   from  the 
floating  debt  would  be  through  foreclosure  and  sale  of 
the  property,  and  this  path  does  not  lead  to  reorganiza- 
tion.    The  reorganization  committee,  therefore,  must  by 
some  means  raise  cash  sufficient  to  meet  all  this  floating 
debt  in  order  that  the  reorganized  company  may  begin 
business.     Furthermore,   there  must  be  enough  cash 
left  over  to  provide  the  reorganized  company  with  a 
fair  working  capital;  otherwise  it  will  begin  at  once 
to  get  into  new  difficulties,  as  is  well  illustrated  by  the 
career  of  the  Detroit,  Toledo  and  Ironton  Railroad 
reviewed  in  the  last  chapter.     The  committee  also,  if  it 
desires  to  have  the  reorganized  company  prosper,  must 
see  to  it  that  its  fixed  charges  are  not  larger  than  its 
minimum  net  earnings.    We  have  thus,   four  main 
objects  of  every  reorganization:  (a),  to  pay  the  float- 
ing debt;  (b),  to  provide  working  capital;  (c),  to  bring 
the  property  up  to  at  least  normal  efficiency;  (d),  to 
reduce  fixed  charges  below  minimum  earnings. 

The  first  three  of  these  objects  require  cash  in  large 
amounts;  especially  is  this  true  since  a  company  which 
is  approaching  insolvency  almost  always  lets  its  ac- 
counts payable  accumulate,  its  working  capital  decline, 


PRINCIPLES  OF  REORGANIZATION 


476 


and  its  property  become  impaired.  Of  course,  this  may 
not  be  the  situation  at  all  if  the  corporation  has  simply 
met  with  some  temporary  reverse,  which  brought  it 
into  a  condition  of  legal  insolvency.  In  such  a  case  the 
problems  of  reorganization  are  comparatively  simple. 
As  a  general  thing,  however,  the  reorganization  com- 
mittee will  find  it  necessary  to  raise  cash  from  every 
available  source.  As  sufficient  cash  makes  the  attain- 
ment of  the  first  three  objects  named  above  easy,  we  may 
say  that  the  reorganization  committee  will  consider  two 
things  of  prime  importance:  first,  to  raise  cash;  second. 
to  reduce  fixed  charges. 

267.  Raising  cash  by  assessments. — There  are  three 
possible  methods  of  securing  cash;  first,  by  the  sale  of 
some  of  the  corporate  property;  second,  by  the  issue  of 
new  securities;  third,  by  assessments  on  the  security- 
holders. The  first  method  is  almost  never  practicable. 
If  the  corporation  possesses  outlying  property  non- 
essential to  its  business,  it  is  more  than  likely  that  this 
property  has  been  heavily  mortgaged  and  must  be 
turned  over  to  the  mortgagees.  The  second  method,  as 
a  general  thing,  is  equally  impracticable.  Obviously 
a  corporation  is  not  likely  to  fail  unless  it  has  already 
exhausted  its  borrowing  power,  and  the  sale  of  the  stock 
of  an  insolvent  corporation  is  out  of  the  question. 
These  considerations  again  do  not  necessarily  apply 
wlien  the  corporation  is  not  a  true  insolvent  but  has 
merely  suffered  a  temporary  setback.  Even  in  true 
insolvency  cash  is  sometimes  raised  through  consider- 
able issues  of  receivers'  certificates,  which  in  reorgan- 
ization are  funded  along  with  the  first  mortgage  bonds 
into  a  ne  first  mortgage  issue.  At  times  this  may  be 
entirely  proper  and  expedient.  The  efficiency  of  the 
corporation's  assets  may  have  become  impaired  and  a 


476 


CORPORATION  FINANCE 


httle  cash  raised  by  receivers'  certificates  may  put  them 
into  such  a  condition  as  to  enhance  its  earning  power 
vastly  more  than  the  amount  of  the  extra  fixed  charges 
thus  imposed. 

The  third  method— assessment  on  the  securitv-holders 
-IS  almost  universal.     Naturally  the  first  and  heaviest 
assessments  fall  on  the  common  and  preferred  stock- 
holders.    The  possibility  of  raising  cash  by  this  method 
is  limited  by  the  stockholders'  estimate  of  the  value  of 
the  stock  of  the  reorganized  company.     They  are  given 
the  choice  either  of  paying  the  assessment  or  of  for 
feitmg  their  equity  in  the  corporation's  assets.     If  the 
assessment  is  made  too  high  evidently  the  stockholder 
will  choose  to  forfeit  whatever  rights  remain  to  him 
rather  than  to  pay  what  is  asked.     The  reorganization 
committee  will  therefore  endeavor  to  keep  the  assess- 
ment down  to  what  it  considers  a  reasonably  low  figure. 
Under    these    conditions    the    average    stockholder 
almost  always  finds  it  worth  while  to  pay  his  assessment 
and  retam  an  interest  in  the  company.     If  he  cannot 
raise  the  necessary  cash  he  will  sell  his  stock  in  the  open 
market  for  whatever  it  will  fetch  to  someone  who  has 
both  the  courage  and  the  means  to  meet  the  assessment. 
It  IS  almost  always  true  that  the  stock  of  a  failed  com- 
pany sells  at  an  abnormally  low  figure.     It  is  frequently 
true  that  a  short  time  after  reorganization,  the  stock 
of  the  reorganized  company  sells  at  a  price  considerably 
above  the  price  of  the  old  stock  during  the  receivership 
plus  the  assessment.     In  other  words,  experience  has 
demonstrated  that  the  stockholder  will  d„  better  if  he 
sticks  with  the  company  than  if  he  forfeits  or  sells  his 
shares.     By    paying    the    assessment    be    reduces    his 
losses. 

Sometimes,  although  rarely,  it  becomes  necessary  to 


PRINCIPLES  OF  REORGANIZATION  477 

assess  the  junior  bondholders  also.     It  seems  strange 
that  a  creditor  of  the  corporation  should  ever  be  forced 
to  pay  an  assessment  in  order  to  remain  a  creditor,  yet 
the  logic  of  the  situation  compels  the   bondholders, 
when  they  are  thus  as  ;essed,  to  accept  it  with  as  good 
grace  as  they  can  muster.     The  bondholders  will  not 
;m<l  caimot  equitably  be  compelled  to  pay  unless  the 
hurden  is  too  heavy  for  the  stockholders  to  carry  alone. 
If  the  amount  of  cash  needed  is  so  large  that  most  of 
the  stockholders  would  rather  lose  their  equity  in  the 
property  than  furnish  their  proportion  of  the  cash,  the 
bondholders  find  themselves  in  an  unpleasant  dilemma. 
Either  they  must  take  some  of  the  burden  off  the  stock- 
holders' shoulders,  or  they  must  take  the  whole  burden 
themselves  and  eliminate  the  stockholders  altogether. 
Almost   always    they  prefer   the    former   alternative. 
When  the  Atchison,  Topeka  and  Santa  Fe  Railroad, 
for  instance,  was  reorganized  in  1894,  the  cash  require- 
ments were  so  large  that  each  stockholder  would  have 
been  compelled  to  pay  in  the  neighborhood  of  $14  per 
share,  and  it  was  more  than  doubtful  if  the  stock  of  the 
reorganized  company  was  worth  this  amount.     The  re- 
organization committee,  therefore,  imposed  $4  of  the 
assessment  on  the  junior  bondholders. 

Usually  the  cash  needed  by  the  company  is  not 
recjuired  at  once,  and  the  terms  of  payment  of  the 
assessments  may  therefore  be  made  fairly  easy,  thus 
reserving  some  of  the  cash  resources  of  the  corporation. 
Another  means  of  providing  funds  for  future  use  is  to 
l»asc  the  l)ond  issues  of  the  reorganized  company  on  a 
limited  open-end  mortgage,  so  that  the  company  need 
not  be  hampered  for  many  years  to  come  by  a  dearth  of 
funds. 

208.  Reducing  fibred  charges.— Uav'mg  provided  the 


I 


t  ■ 


478 


CORPORATION  FINANCE 


reorganized  company  with  sufficient  cash,  the  reorgani- 
zation committee  now  takes  up  its  final  and  most  difficult 
problem,  reduction  of  fixed  charges.     The  fixed  charges 
tha    may  be  affected  are  of  three  kinds:  guarantees, 
rentals  and  mterest.     A  company  may  be  dissolved 
m  reorganization,  in  which  case  it  is,  of  course,  released 
.rom  Its  previous  contracts  and  the  reorganized  com- 
pany  may  or  may  not  renew  them.     If  guarantees 
of  m  erest  and  dividends  on  subsidiary  company  securi- 
ties  have   proved   burdensome   and   unprofitable,   the 
reorganization  committee  has  an  opportunity  to  dis- 
pense  with  them.     It  does  not  follow  that  the  com- 
mittee will  always  take  this  action.      The  guarantee 
may  be  necessary  in  order  to  hold  control  of  the  sub- 
sidiary companies.     Frequently,  however,  the  holders 
of  the  guaranteed  stock  and  bonds  will  submit  to  a  re- 
duction  of  the  guarantee  rather  than  take  back  their 
property. 

Much  the  same  thing  may  be  said  of  rentals.  The 
ov^ers  of  a  leased  property  would  ordinarily  have  great 
difficulty  m  leasing  it  to  any  other  corporation  and  could 
not  very  well  operate  it  themselves.  Especially  is  tnis 
true  when  the  leased  pn.perty  has  been  constructed  in 
the  interest  of  the  failed  corporation.  The  owners, 
tlierefore,  have  practically  no  choice  in  the  matter. 
They  must  submit  to  any  reasonable  reduction  thit  the 
reorganization  committee  demands. 

Far  more  important  usually  in  its  effect  on  fixed 
charges  is  the  substitution  for  the  interest-bearing  securi- 
ties of  the  old  corporation  of  dividend-paving  securities 
of  tlu'  new  corporation.  Sometimes,  also",  old  securities 
which  bear  interest  at  a  high  rate  are  converted  into  new 
securities  bearing  interest  nt  a  low  rate.  The  result  of 
this  readjustment,  if  the  reorganization  is  to  prove  sue- 


w^m 


PRINCIPLES  OF  REORGANIZATION 


479 


cessf  ul,  must  be  to  bring  the  total  fixed  charges  below  the 
net  earnings  of  the  corporation  even  in  the  worst  years. 
Ordinarily  the  reorganization  committee  will  first  make 
a  conservative  estimate  of  the  lowest  earnings  likely 
to  occur  in  the  future  and  will  cut  down  interest 
charges  accordingly.  O'  course  this  reduction  is  not 
proportionate  on  all  the  bond  issues,  but  is  adjusted  in 
accordance  with  the  relative  strength  of  the  various 
claims  against  the  corporation,  as  already  indicated. 

One  of  the  great  advantages  of  reorganization  is 
the  possibility  which  it  affords  of  unifying  and  simpli- 
fying the  complicated  and  sometimes  conflicting  obliga- 
tions that  have  been  imposed  at  various  times.  The 
reorganization  committee  will  usually  arrange  for  a 
few  comprehensive,  well-defined  mortgages  in  place  of 
the  numerous  mortgages  previously  existing  and  will 
increase  the  amount  authorized  under  each  mortgage. 
This  principle,  however,  cannot  be  extended  too  far. 
The  committee  cannot,  for  instance,  without  getting 
into  legal  difficulties,  absorb  any  of  the  old  bond  issues, 
interest  on  which  has  imquestionably  been  earned  for 
several  years  previous.  The  old  first  mortgage  issue 
and  the  first  mortgage  bonds  on  highly  important 
specific  pieces  of  property  will  therefore  generally  be 
left  untouched.  On  top  of  them,  however,  the  com- 
mittee may  impose  a  •^ew  general  mortgage  bond 
issue  of  large  size  sufficient  to  refund  all  the  existing 
issues  that  are  to  be  absorbed,  to  refund  the  old  first 
mortgage  bonds  when  they  finally  fall  due  and  to  pro- 
vide for  necessary  improvements  and  cxt^ensions.  This 
^'eneral  mortgage  issue  will  be  designed  evidently  to 
hccome  in  time  a  first  lien  on  all  the  corporation  prop- 
erty.   For  these  new  general  mortgage  bonds  the  old 


480 


CORPORATION  FINANCE 


IH 


junior  bonds  will  be  exchanged  on  such  terms  as  may  Be 
finally  agreed  to. 

269.  Capitalization  of  the  reorganized  corporation. 
— Assuming   that   the   reorganization   committee   has 
succeeded  in  determining  the  relative  values  of  the 
various  issues  of  mortgage  bonds,  it  may  now  proceed 
to    a    corresponding    allotment    of    the    new    general 
mortgage  bonds.     Suppose,  for  instance,  that  there  had 
been  outstanding  $1,000,000  second  mortgage  bonds, 
$^.00,000  branch  line  bonds  and  $1,. 500,000  debenture 
bonds  and  that  the  new  general  mortgage  issue  avail- 
able for  exchange  is  fixed  on  the  basis  of  the  lowest 
earnings  at  $2,000,000;  suppose  also  that  the  reorgan- 
ization committee  estimates  the  first-named  issue  on  the 
basis  of  lowest  earnings  tv   '.e  worth  80  per  cent  of  its 
par  value,  the  second-named  issue,  60  per  cent,  and  the 
third-named  issue,  60  per  cent:     It  would  then  offer 
to  the  bondholders  of  the  first  class  $800  in  new  general 
mortgage  bonds  for  each  $1,000  of  the  old  bonds,  and  to 
the  bondholders  of  the  second  and  third  classes,  $600 
in  the  new  bonds  for  $1,000  of  the  old  bonds.     As  the 
values  of  the  old  issues  and  the  amount  of  the  new  issue 
are  figured  on  the  same  basis,  lowest  net  earnings,  they 
must,  of  course,  exactly  correspond.     Not  every  case  is 
so  simple  by  any  means,  as  our  illustration.     The  same 
principle,  however,  would  always  be  applied. 

It  is  felt  to  be  equitable,  as  well  as  necessary  in  order 
to  satisfy  the  bondholders,  that  they  should  be  com- 
jjensated  for  the  reduction  of  their  interest-bearing 
principal.  This  is  accomplished  by  giving  them  at 
least  enough  dividend-paying  principal  to  bring  the  par 
value  of  their  holdings  in  the  reorganized  company  up 
to  an  equality  at  least— sometimes  considerably  more 
than  an  equality— with  the  par  value  of  their  old  secur- 


PRINCIPLES  OF  REORGANIZATION  4,81 


ities.  Formerly  it  was  customary  to  give  them  the 
difference  between  the  par  value  of  their  old  bonds  and 
the  par  value  of  their  allotment  of  new  interest-bearing 
bonds  in  the  form  of  income  bonds.  Income  bonds 
have  already  been  described  and  characterized.  They 
are  a  fallacy  and  a  delusion  and  at  the  present  time  are 
practically  unused.  Their  place  in  reorganization  has 
now  been  taken  by  preferred  stock.  The  debenture 
bondholder  in  our  illustration  who  got  $600  in  new  bonds 
for  $1,000  in  old  bonds  would  under  the  present  practice 
probably  get  also  at  least  $400  in  preferred  stock.  He 
thus  has  a  chance  to  share  in  the  future  prosperity  of  the 
company.  He  may  well  hope  and  even  expect  that  in 
the  end  he  will  more  than  recover  his  losses.  The  same 
principle  is  applied  to  all  the  other  bondholders,  so  far 
as  practicable,  and  even  to  the  preferred  and  common 
stockholders.  It  follows  that  one  usual  and  almost 
necessary  result  of  a  reorganization  is  a  great  increase 
in  capitalization.  The  reorganization  committee  en- 
deavors to  remedy  the  failures  and  disappointments  of 
tlie  past  and  present  by  drawing  heavy  drafts  on  the 
future.  It  is  only  fair  to  say  that  in  this  coimtry  these 
drafts  have  usually  sooner  or  later  been  honored. 

The  final  problem  which  the  reorganization  committee 
must  settle  is  whether  to  revive  the  old  company  and  the 
old  charter  or  to  take  out  a  new  charter  and  organize  a 
new  company.  Tiie  first  course  involves  a  maintenance 
('('  all  the  previously  existing  contracts  and  obligations 
of  the  comp;»ny  not  provided  for  in  the  reorganization 
scheme.  lis  advantage,  of  course,  lies  in  the  retention 
of  tlu'  charter  which  may  perhaps  confer  valuable 
privileges.  The  question  is  at  bottom  legal  rather  than 
financial.  In  truth,  it  is  a  matter  usually  of  no  very 
great  consequence. 
C— VI— .-ji 


i 


482 


CORPORATION  FINANCE 


Iff 


To  insure  stability  of  financial  mangement,  until 
after  the  reoganized  company  is  well  started,  it  is  not 
uncommon  to  place  the  new  stock  in  the  hands  of  a  vot- 
ing trust  for  a  period  of  years.  The  nature  and 
operations  of  such  a  trust  have  already  been  described. 

270.  Summary  of  the  chapter.— Briedy  the  principles 
and  the  results  of  reorganization  may  be  summed  up  as 
follows : 

(a)  The  reorganization  must  remove  the  immediate 
causes  of  bankruptcy  by  providing  cash  and  at  the  same 
time  reducing  fixed  charges. 

(b)  The  reduction  of  securities  bearing  fixed  charges 
may  well  be  and  usually  is  accomplished  by  a  great 
increase  of  dividend-paying  securities. 

(c)  In  determining  who  shall  stand  the  losses  caused 
by  the  company's  insolvency,  the  reorganization  com- 
mittee will  first  rank  the  securities  in  the  order  of  their 
safety  and  will  then  impose  the  losses  in  inverse  order. 

(d)  In  so  doing  the  directors  must  of  necessity  con- 
sider primarily  the  ability  of  the  security-holders  to 
make  trouble  for  or  to  wreck  the  reorganized  company 
if  their  demands  are  not  satisfied. 

(e)  In  raising  necessary  cash  they  will  naturally  im- 
pose the  first  and  heaviest  assessments  on  stockholders, 
but  they  must  bear  in  mind  that  if  they  go  beyond 
certain  limits  the  stockholders  will  forfeit  their  shares 
rather  than  pay  the  assessments. 

The  working  out  of  these  principles  will  be  further 
discussed  in  connection  with  the  illustrations  cited  in  the 
following  chapter. 


^:i^9^Bm 


CHAPTER  XXXI 


THREE  TYPICAL  REORGANIZATIONS 

271.  Growth  of  the  Santa  Fe  System. — The  prin- 
ciples of  reorganization  laid  down  in  the  preceding  chap- 
ter will  be  much  better  understood  if  we  consider  their 
application  in  a  few  typical  instances.  For  this  pur- 
pose we  will  take,  first,  the  forced  reorganization  of 
tlie  insolvent  Atchison  Topeka  and  Santa  Fe  Railroad 
Company  in  1894;  second,  the  voluntary  reorganization 
of  the  prosperous  Chicago,  Rock  Island  and  Pacific 
Railway  Company  in  1902;  third,  the  forced  reorganiza- 
tion of  the  Westinghouse  Electric  Iklanufacturing  Com- 
pany in  1908. 

It  is  necessary  to  go  back  several  years  in  order  to  get 
a  typical  case  of  a  large  railroad  receivership  and  re- 
organization, for  American  railroads  in  the  last  fif- 
teen years  have  enjoyed  extraordinary,  and  up  to  1907 
almost  uninterrupted,  prosperity.  It  is  true  that  a 
considerable  number  of  railroad  systems,  including  the 
Seabord  Air  Line,  the  Chicago  Great  Western,  the  De- 
troit, Toledo  and  Ironton,  the  Chicago,  Cincinnati  and 
Louisville,  the  International  and  Great  Northern,  the 
Western  Maryland  and  the  Macon  and  Birmingham 
Ment  into  the  hands  of  receivers  as  the  result  of  the  fi- 
nancial panic  of  October,  1907.  None  of  these  roads, 
however,  is  of  first-rate  importance  and  their  problems 
•lid  not  prove  as  intricate  and  difficult  a;  the  problems 
of  the  numerous  railroad  reorganizations  following  th« 
Kreat  crisis  of  1898.    We  shall  find  it  therefore  more 

483 


li 


484 


CORPORATIOxN  FINANCE 


instructive— even  if  not  of  so  great  current  interest-^ 
to  study  one  of  the  1893  reorganizations  rather  than 
one  of  later  date.* 

Like  most  of  our  great  railroad  systems,  the  Atchi- 
son, Topeka  and  Sante  Fe  has  grown  by  leaps,  so  to 
speak.     It  was  chartered  in  Kansas  in  the  year  1863, 
and  construction  on  the  first  section  of  the*  road  was 
begun  in  1869.     The  main  line  from  Kansas  City  to 
Colorado,  thence  in  a  southerly  direction  to  Albuquer- 
que,  Xew  :Mexico,   and  thence  southwest  to  a  con- 
nection with  the  Southern  Pacific  Railroad  at  Deming, 
Arizona,  was  not  completed  until  1881.     In  1882  the 
Atchison  exchanged  its  stock  for  the  stock  of  the  Sonora 
Railroad,  and  thus  secured  an  entrance  of  Guaymas, 
^Mexico.     The  company  by  using  a  s.'^tion  of  the  track 
of  the  Southern  Pacific  had  a  through  route  from  Kan- 
sas City  to  the  Pacific  Coast.     To  appreciate  the  im- 
portance of  reaching  the  Pacific  Ocean  it  must  be  borne 
in  mind  that  trafl^ic  from  any  of  the  Pacific  Coast  ports 
may  move  readily  and  cheaply  by  water  to  any  other 
of  these  ports.    The  Santa  Fe  was  therefore  in  a  posi- 
tion to  take  through  business  by  its  part-water-and- 
part-rail  route  from  any  point  on  the  Pacific  Coast  to 
the  East. 

This  route,  though  important,  could  not,  however, 
bring  to  the  Santa  Fe  a  large  proportion  of  the  traflfic  to 
and  from  the  Pacific  Coast  in  the  face  of  the  existing 
competition  of  the  all-rail  routes,  particularly  of  the 
Santa  Fe's  chief  competitor,  the  Southern  Pacific. 
President  Strong  of  the  Sante  Fe  therefore  entered  into 

1  Acknowlcdprnent  should  be  made  hero,  in  oonnpotion  with  the  following 
reviews  of  the  S:.nt.<  Vv  and  Rook  Island  reorjjr.mirntinns,  of  the  Inforiua- 
tion  oI.tHincd  from  .  fr.  Stuart  Da^jrett's  "Railroad  Ue-Orjranization."  Most 
of  what  follows  as  to  these  two  companies  is  hnsed  on  Mr  Dosrm-tt's  re- 
searclies.  He  is  one  of  the  first  to  brinp  to  Ixvir  on  financial  problems  the 
thorough,  scientific  methods  of  university  scholarship. 


TYPICAL  REORGANIZATIONS 


485 


an  alliance  with  the  St.  Louis  and  San  Francisco  Rail- 
road, which  owned  the  charter  of  a  company  known  as 
the  Atlantic  and  Pacific  Railroad  Company.     By  the 
terins  of  this  alliance  the  two  roads  jointly  financed  the 
operations  of  the  Atlantic  and  Pacific  and  by  means 
of  purchase  and  of  new  construction  endeavored  to 
secure   a  through   rail   route   to   San  Francisco.     In 
188.5 — one  of  the  great  railroad  building  years  of  the 
•United  States — the  Atchison,  by  construction,  purchase 
and  lease  combined,  managed  to  reach  Los  Angeles. 
The  main  line  of  the  road  still  had  its  eastern  terminal, 
however,  at  Kansas  City  and  the  system  did  not  reach 
the  Gulf  of  Mexico,  or  in  fact  any  of  the  rapidly 
developing  agricultural  country  south  of  Kansas.     To 
remedy  this  defect  a  road,  known  as  the  Gulf,  Colorado 
and  Santa  Fe,  had  been  constructed,  partly  in  the 
interest  of  the  Santa  Fe,  from  Galveston  to  a  point 
about  two  hundred  miles  north,  and  another  line  known 
as  the  Southern  Kansas  Railroad  was  built  south  from 
Arkansas  City  to  connect  with  the  track  of  the  Gulf, 
Colorado  and  Santa  Fe.     In  1886  the  stock  of  the  last- 
named  road  was  bought  by  the  Atchison  and  the  bonds, 
to  the  extent  of  about  $17,000  per  mile,  were  assumed. 
In  1887  the  Atchison  purchased  the  Chicago  and  St. 
Louis  Railroad  between  Chicago  and  Streator,  Illinois, 
and  other  subsidiary  companies  constructed  new  track 
up  to   Streator.     By  1888   it  had  thus  obtained   its 
Chicago  entrii  ce. 

In  the  meantime  between  '86  artd  '89  it  had  built  a 
large  number  of  branch  lines  in  all  directions  largely 
for  the  purpose  of  forestalling  competition.  "The 
method  of  financing  these  competitive  extensions 
varied,"  says  Mr.  Daggett.  "Sometimes  the  parent 
company  guaranteed  the  principal  and  interest  of  the 


li   ' 


486  CORPORATION  FINANCE 

branch  line  bonds;  sometimes  it  took  these  into  its 
treasury  and  issued  collateral  bonds  against  them; 
sometimes,  perhaps  more  frequently  still,  it  leased  new 
roads  for  a  rental  equivalent  to  the  annual  interest  on 
their  bonds.  If  the  branches  could  have  earned  their 
fixed  charges,  the  burden  of  the  Atchison  would  have 
been  nominal,  but  as  in  large  part  they  could  not,  it  was 
real  and  serious." 

The  results  of  the  rapid  expansion  of  the  Santa  Fe 
from  1884  to  1888  are  well  summarized  by  Mr.  Daggett 
in  the  following  table: 

1884  1888 

Mileage 2,799  7,010 

Bonds   $48,258,500  $163,694,000 

Stock  (Atchison)    60,673,150  75,000,000 

Gross  earnings 16,699,662  28,265,339 

Operating  expenses 9,410,424  21,958,195 

Net  earnings  from  operation  7,289,237  6,307,145 
Net    profits    excluding    divi- 
dends    5,147,883  def.         2,933,197 

Net   profits,   including  pay- 
ments   for   dividends    and 

interest  on  floating  debt . .  def.         5,557,323 

It  should  be  noted  that  while  the  bond  indebtedness 
(including  the  assumed  bonds  of  subsidiary  companies) 
had  considerably  more  than  tripled,  gross  earnings  had 
increased  only  about  70  per  cent  and  net  earnings  from 
operation  had  declined.  Evidently,  unless  this  tendency 
should  be  speedily  reversed,  the  company  was  doomed 
to  insolvencj\  In  addition  the  floating  debt  had  in- 
creased from  approximately  $3,300,000  in  1884  to  over 
$8,000,000  in  1888,  and  the  road  had  consequently  been 
forced  to  authorize,  in  October,  1888,  $10,000,000  of 
three-year  notes. 


TYPICAL  REORGANIZATIONS 


487 


272.  First  reorganization  of  the  Santa  Fe  and  its 
results. — The  situation  was  so  obviously  dangerous  that 
a  committee  of  the  directors  was  appointed  in  1889  to 
l)iing  about  a  friendly  reorganization  and  thereby  to 
avert  bankruptcy. 

About  one-third  of  the  $163,000,000  of  bonds  were 
direct  obligations  secured  by  mortgages  on  the  Atchi- 
son's own  property,  while  the  other  two-thirds  con- 
sisted of  obligations  of  thirty-two  subsidiary  companies. 
From  what  has  been  said  in  the  preceding  chapter,  it 
will  be  seen  that  the  entanglements  and  conflicts  of  these 
various  issues  were  almost  beyond  unraveling.  The 
directors  first  aimed  at  simplification  and  with  that 
object  in  view  suggested  that  two  large  issues  be  put 
forth,  one  of  4  per  cent  general  mortgage  bonds,  to  the 
amount  of  $150,000,000,  and  one  of  5  per  cent  income 
bonds  to  a  total  of  $80,000,000.  Some  $14,000,000 
were  to  be  sold  in  order  to  raise  necessary  cash  and  the 
remainder  of  the  two  bond  issues  was  to  be  exchanged 
for  the  numerous  existing  issues.  Income  bonds  were 
much  used  in  reorganization  at  that  period  and  were  not 
received  with  the  distrust  which  they  now  excite.  The 
proposal  to  the  original  bondholders  that  they  should 
exchange  their  mortgage  bonds  in  part  for  income  bonds 
was  not,  of  course,  altogether  palatable;  yet  it  must 
be  remembered  that  the  bonds  which  were  to  be  thus 
exchanged  had  always  been  regarded  as  more  or  less 
speculative  in  character  and  had  for  that  reason  been 
sold,  for  the  most  part,  well  below  par,  and,  further- 
more, that  the  branch  line  bondholders  would  have  lost 
rather  than  gained  by  a  forced  bankruptcy  and  fore- 
closure sale.  Moreover,  the  basis  of  the  exchange  was 
such  as  to  compensate  them  in  part  for  their  loss  of  fixed 
interest  payments  by  a  larger  principal.     In  other 


f!ll 


fe    •; 


:|f  . 


till 
i     :   till 


488 


CORPORATION  FINANCE 


H 


! 


J 


ll 


I; 


words,  as  usually  happens  in  reorganizations,  the  com- 
pany proposed  to  cut  down  its  current  fixed  charges  and 
held  out  m  place  thereof  hopes  of  high  optional  pay 
ments  m   the  future.     The  reorganization  plan  was 
accepted  and  put  into  effect. 

After  this  reorganization,  the  Atchison  policy  of  rapid 

In  1890,  by  an  exchange  of  securities,  the  St.  Louis  and 

svsl  J'^r     "'^""'-^  ''''  ^^'"'^'^^^  '"*°  the  Atchison 
s    tern     Tins  acquisition  of  1,300  miles  at  one  stroke 

did  not  prove  nearly  as  profitable  as  was  anticipated 
In  the  same  year  the  Colorado  Midland  346  miles  long 
was  purchased.  ®' 

When  the  $10,000,000  note  issue  of  1888  fell  due 
m  1891,  the  directors  fcuiid  themselves  unable  to  meet 
the  payment  out  of  earnings  and  therefore  arranged 
for  a  two-year  extension.     In  1892  the  need  of  addi- 
tional funds  for  improvements  and  extensions,  which,  as 
the  reader  may  have  noted,  had  not  been  at  all  provided 
for  m  the  reorganization  of  1889,  made  necessary  a  new 
issue  of  second  m...  tgage  bonds.  As  the  terms  of  issue  of 
the  $80,000,000  income  bonds  forbade  anv  prior  lien  (ex- 
cept the  first  mortgage)  being  placed  upin  the  property 
It  was  necessary  before  placing  a  second  mortgage  to 
arrange  for  the  protection  of  the  income  bondholders. 
Ihis  was  accomplished  by  making  the  second  mortga-e 
cover    an    issue    of   $100,000,000    4    per   cent    boncFs 
.80,000  000  of  which  wc-e  to  be  exchanged  dollar-for- 
(lol  ar  for  the  income  bonds,  and  $20,000,000  to  be 
sold  for  cash.     Thus  in  1893,  by  a  coincidence,  whicli 
may  be  called  unfortunate,  but  which  with  wise  manage- 
ment would  never  have  occurred,  the  Atchison  had  to 
face  largely  increased  fixed  charges  and  the  pajTnent  of 
the  $10,000,000  note  issue,  both  coming  at  the  same  time 


TYPICAL  REORGANIZATIONS 


489 


with  the  panic  and  the  traffic  losses  of  that  disastrous 
year.  In  January,  1894,  the  inevitable  insolvency 
arri\'ed. 

173.  Second  reorganhation  and  its  results.— Several 
bondholders'  committees,  according  to  the  custom  in  re- 
oivranization,  were  quickly  formed.  Among  others  the 
English  holders  of  second-mortgage  bonds  sent  over  a 
strong  committee  which  put  forward  what  was  known 
as  the  English  plan  of  reorganization. 

This  plan  involved  foreclosure  either  by  the  first  or 
second  mortgage  bondholders.  In  either  case  the  first 
mortgage  issue  would  be  left  undisturbed  and  overdue 
interest  would  be  paid  either  in  cash  or  in  new  securities. 
A  new  income  mortgage  bond  issue  was  to  be  exchanged 
for  the  second  mortgage  bonds  and  was  also  to  provide 
compensation  for  an  assessment  of  $12  per  share  on  the 
stockholders.  By  paying  this  assessment  the  stock- 
holders would  retain  their  stock  interest  in  the  road,  as 
well  as  receive  income  bonds.  The  income  bonds  were 
to  have  voting  power.  The  substance  of  the  plan,  it 
is  evident,  was  to  reverse  the  former  conversion  of  in- 
come bonds  into  second  mortgage  bonds.  In  the  re- 
conversion the  English  bondholders  were  to  secure  an 
increase  in  principal  and  the  important  privilege  of 
voting.  The  plan  was  not  acceptable  to  the  stock- 
holders, however,  who  felt  that  part  of  the  load  thus 
itn posed  upon  them  ought  rightfully  to  be  borne  by  the 
second  mortgage  bondholders. 

Before  the  argument  had  been  carried  far  a  new  factor 
was  introduced  into  the  situation,  namely,  the  publica- 
tion of  the  report  of  ^Ir.  Stephen  Little,  an  expert  ac- 
countant who  had  thoroughly  ir  x-stigated  the  Atchison 
l)ooks.  Mr.  Little  found  that  by  means  of  peculiar  fic- 
titious accounts— most  important  of  which  was  an  ac- 


^'i| 


■'  f>" 


II 


>u 


■   ■  i 


1 


"I 


490  CORPORATION  FINANCE 

count  that  carried  rc!)ate.s  by  the  company  as  an  asset— 
the  recorded  earnings  of  the  railroad  had  been  deliber- 
ately inflated.  The  annual  net  earnings,  according  to 
the  company's  reports,  had  been  as  follows: 

1891 $  7,631,598 

1«92 10,953,896 

1«93 12,126,866 

Accoiding  to  Mr.  Little  they  should  have  been: 

1891 $  5,204,880 

1892 7,853,173 

1 893 8,085,608 

1894 5,956,615 

This  startling  anouncement  completely  changed 
the  plans  which  had  been  formulated.  It  was  evident 
that  H  far  more  radical  reduction  of  fixed  charges  would 
be  essential. 

A  new  committee  proposed  the  second  and  finel  re- 
organization i)lan  in  March,  181).).  The  purposes  of  this 
plan  were  stated  to  be : 

(a)  To  reduce  fixed  charges  to  a  safe  limit; 

(b)  To  pro\  ide  for  future  capital  requirements; 

(c)  To  liquidate  the  floating  debt; 

(d)  To  reinstate  existing  securities  upon  equitable 
terms  in  the  order  of  their  priority; 

(e)  To  consolidate  and  unify  the  system. 

The  committee  proposed  foreclosure  under  the  first 
mortgage  and  the  formation  of  a  new  railway  company 
which  was  to  issue 

(a)  Commo»'  '^tock .Jj^l 02,000,000 

(b)  .5  per    ,    .  non-cumulative  preferred 

stock     $111,486,000 


^^ 


TYPICAL  REORGANIZATIONS 


491 


(c)  General  4  per  cent  bonds .$96,990,582 

(d)  Adjustment  ^  4  per  cent  bonds $51,728,310 

Old  common  stockholders  were  to  receive  share  for 
share  new  common  stock  provided  they  paid  an  assess- 
iiiciit  of  $10  per  share  and  for  this  $10  were  to  receive 
sio  i.i  new  preferred  stock.  An  underwriting  syndicate 
una -anteed  to  take  the  place  of  defaulting  stockholders. 
The  old  general  mortgage  bondholders  were  given  75 
per  cent  of  their  holdings  in  new  general  mortgage 
bonds  and  40  per  cent  in  adjustment  bonds.  The 
.second-mortgage  bondholders  were  to  be  assessed  $4  for 
every  $100  of  their  holdings  and  were  to  receive  113  per 
cent  in  new  preferred  stock.  It  was  provided  that  ad- 
ditional bonds  under  the  general  mortgage  might  be  is- 
sued at  the  rate  of  $3,000,000  per  year  up  to  a  limit  of 
.^30,000,000  and  that  thereafter  additional  adjustment 
bonds  might  be  issued  at  the  rate  of  $2,000,000  per  year 
lip  to  a  limit  of  $20,000,000. 

The  St.  Louis  and  San  Francisco  Railroad  and  some 
other  smaller  subsidiary  lines  were  not  included  in  the 
reorganization  plan,  but  were  turned  over  to  their  own 
1  ondholders. 

It  will  be  seen  that  this  plan  accomplished  the  Ave 
purposes  named  by  the  committee.  It  brought  about 
a  very  radical  reduction  of  fixed  charges  affecting  even 
tile  first  mortgage  bondholders.  It  gave  room  for  ad- 
ditional issues  of  bonds  under  certain  restrictions  to 
jirovide  for  future  improvements  and  extensions.  It 
lirought  in  about  $14,000,000  cash  to  meet  current  ob- 
1  ignitions.  It  retained  the  relative  claims  of  the  various 
security-holders  to  the  road's  assets  and  earnings.  Fi- 
nally, by  lopping  ofiP  nonessential  lines,  it  helped  to  con- 
!>ulidate  and  unify  the  system. 

iThe  so-cnlled  adjustment  t>onds  wetv  in  reality  Income  bonds. 


n 


i;f 


492  CORPORATION  FINANCE 

The  principal  opposition  to  the  plan  came  from  some 
of  the  minority  stockholders  who  believed  that  the  for- 
mer management  had  proved  untrue  to  then  interests 
and  that  this  management  had  not  been  entirely  elimi- 
nated. This  opposition,  however,  was  unable  to  muster 
enough  votes  to  defeat  the  reorganization  plan 

The  high  credit  and  prosperity  of  the  Atchison  in  the 
last  few  years  indic.:tes  that  the  reorganization  was  car- 
ried through  on  sound  lines.  There  has  never  been  a 
question  raised  since  the  reorganization  but  that  the  com- 
pany could  easily  meet  all  its  obligations.  The  road  has 
been  greatly  improved  and  strengthened  physically  and 
earnings  have  grown  far  more  rapidly  than  expenses. 
The  changes  in  the  decade  following  1897  are  shown  in 
the  following  tabulation: 

1897  1907 

^^'^^age 6,479  9,273 

Gross  earnings $30,621,230         $93,683,407 

Net  earnings   7,754,041  32,153,692 

Annual  surplus   1,452,446  21,168,724 

Katurally  the  market  price  of  the  Atchison  securities 
has  steadily  risen.  Nobody  suffered  in  the  end  from 
the  reorganization.  On  the  contrary,  all  the  security- 
holders who  retained  their  interests  have  seen  them 
steadily  appreciate  in  value.  The  Atchison  reorgan- 
ization of  1895  may  well  be  taken  as  a  fair  type  of  a 
highly  successful  readjustment  of  charges. 

274.  Growth  of  the  Rock  Island  StjHtem.—We  will 
consider  now  an  entirely  different  kind  of  reorganization 
—one  in  which  not  necessity  but  desire  for  quick  specu- 
lative profits  was  the  controlling  factor.  In  order  to 
understand  the  situation  it  will  be  well  to  review  hastily 
th«  history  of  the  Rock  Island  Railroad.  The  line  was 
completed  between  Chicago  and  Rock  Island  in  1854, 


TYPICAL  reorganization: 


493 


and  from  Rock  Island  to  Council  Bluffs  in  1869.  The 
company  was  prosperous  almost  from  the  beginning. 
Its  road  ran  through  a  well-settled  and  fertile  territory 
where  traffic  was  large  and  certain  and  construction  was 
cheap.  Capitalization  was  very  moderate,  especially  as 
compared  with  many  other  western  railroads  whose  con- 
struction was  paid  for  not  in  cash  but  in  extravagant 
allotments  of  stocks  and  bonds  to  the  contractors.  In 
1880  tlie  road  was  earning  so  much  and  paying  such 
large  dividends  that  it  seemed  desirable  to  water  the 
stock.  This  was  accomplished  by  an  exchange  of  the 
stock  of  the  Chicago,  Rock  Island  and  Pacific  Railroad 
Company  for  the  stock  of  a  new  Chicago,  Rock  Island 
and  Pacific  Railway  Company  in  the  ratio  of  about  two 
to  one  The  new  Railway  Company  also  took  in  some 
other  properties  previously  i  trolled  by  the  Railroad 
Conjpany,  and  was,  therefore,  in  form,  though  not  in 
fact,  a  consolidation. 

The  new  railway  company  d'i  not  continue  to  be  as 
prosperous  as  it  was  in  the  beginning.  The  middle  '80s 
were  hard  years  for  western  railroads,  for  all  of  them 
were  forced  into  competitive  railroad  building,  which  for 
the  time  being  was  largely  unprofitable.  The  Rock  Is- 
land dividends  and  the  market  prices  of  the  road's  se- 
curities suffered  severely.  Nevertheless,  the  road's  man- 
a^rcnient  was  conservative  and  able  and  the  company  not 
only  survived,  but  even  paid  dividends  through  the  try- 
ing depression  of  1893-1897.  After  1897  the  road 
shared  in  the  renewed  prosperity  of  the  United  States 
and  began  in  its  conservative  way  to  plan  for  further 
expansion  and  development. 

In  1901,  however,  the  conscT^atism  of  the  company 
suddenly  disappeared  as  if  the  earth  had  swallowed  it. 
Directors  and  officers  who  had  served  for  years  and  dec- 


i 


494 


CORPORATION  FINANCE 


ades  were  removed,  and  new  men — younger  men  of  an 
entirely  different  type— were  put  into  their  place. 
With  the  older  m  iiere  vanished  also  the  former  ideals 
and  purposes  of  i,.e  company  and  a  very  different  path 
toward  success  and  prosperity  was  entered. 

The  reason  for  these  changes  is  to  be  found  in  the  fact 
that  during  1900  and  1901  a  small  coterie  of  speculative 
promoters  known  as  "the  3Ioore  crowd,"  of  whom  we 
have  heard  in  connection  with  the  formation  of  the 
United  States  Steel  Corporation,  had  quietly  bought  a 
majority  of  the  common  stock  in  the  Wall  Street 
market.  The  process  of  buying  had  been  carried  on  so 
patiently  and  warily  that  it  was  hardly  suspected  and 
the  price  of  the  stock  was  very  little  increased.  The 
financial  world  first  got  an  inkling  of  the  situation  when 
in  April,  1901,  JMr.  William  II.  Moore  and  Mr.  D.  G. 
Reid  were  elected  to  the  directorate. 

The  principal  men  in  the  new  party,  which  now  rap- 
idly assumed  full  control  of  Rock  Islands  affairs,  were 
Mr.  W.  H.  Moore,  his  brother  Mr.  J.  H.  Moore,  Mr. 
D.  G.  Reid  and  Mr.  William  B.  Leeds.     No  one  of 
these  men  had  had  any  experience  -n  railroad  man- 
agerial positions  and  none  of  them  had  ever  been  prom- 
inently identified  before  with  railroad  operations.     All 
of  them,  however,  were  bold  and  successful  speculative 
promoters  and  all  of  them  were  well  versed  in  the  ways 
and  wiles  of  the  speculative  security  market.     Their 
successes  had  been  gaineil  in  the  promotion  of  the  com- 
panies which  were  taken  into  tiie  United  States  Steel 
Corporation.     Their  interest  in  railroad  affairs,  there- 
fore, it  was  easy  to  see,  was  entirely  financial.     They 
did  not  take,  and  as  a  matter  of  fact  never  have  taken, 
any  active  part  in  the  operating  management  of  their 
road.     All  their  energies  have  been  given  to  maintain- 


TYPICAL  REORGANIZATIONS 


495 


ing  its  financial  status  and  at  th«  same  time  directing  for 
their  own  benefit  its  financial  operations. 

In  the  two  annual  meetings  of  June,  1901,  and  June, 
1902,  the  stockholders  increased  their  capital  stock  from 
s^jO,000,000,  at  which  it  had  been  placed  in  1880,  to 
$7.5,000,000.  Also  the  stock  of  some  smaller  roads,  in- 
cluding the  important  Choctaw,  Oklahoma  and  Gulf, 
was  bought  by  the  Rock  Island,  payment  being  made 
partly  in  cash  and  partly  in  Rock  Island  securities. 

275.  Rock  Island  reorganization. — The  "Moore 
crowd"  now  brought  forward  the  scheme  of  reorganiza- 
tion which  they  had  devised  primarily,  it  appears,  with 
a  view  to  selling  a  large  part  of  their  stock  without  los- 
ing control.  The  plan  involved  two  holding  companies 
and  a  double  exchange  of  securities.  It  is  perhaps  the 
most  complex  and  ingenious  scheme  on  a  larjre  scale  for 
attaining  the  purpose  just  named  that  has  yet  been  suc- 
cessfully put  through. 

The  operating  company  under  this  scheme  remained 
the  same  as  it  had  been  since  1880,  the  Chicago,  Rock 
Island  and  Pacific  Railway  Company.  The  first  hold- 
ing company  (whose  prime  object,  apparently,  was  to 
meet  any  legal  objection  that  might  afterwards  arise  to 
the  consolidation  of  competing  railway  companies)  was 
the  Chicago,  Rock  Island  and  Pacific  Railroad  Com- 
pany, incorporated  in  Iowa.  The  second  holding  com- 
pany was  the  Rock  Island  Company,  incorporated  in 
Xew  Jersey.  The  outstanding  bonds  and  other  secu- 
rities of  the  old  "railway"  company  were  left  undis- 
turbed. The  new  "railroad"  company  issued  stock  to 
the  amount  of  $75,000,000.  The  Rock  Island  Company 
issued  .$96,000,000  common  and  $54,000,000  preferred 
stock.  The  last-named  company  then  delivered  $127,- 
■^00,000  of  its  preferred  and  common  stock  to  the  Chi- 


'I 


496 


CORPORATION  FIXAxNCE 


•  n 


cago,  Rock  Island  and  Pacific  Kaihoad  Company  ol 
Iowa  in  exchange  for  all  the  $12.5,000,000  common  stock 
of  tiie  Iowa  company.  After  this  transaction  the  last- 
named  company  had  in  its  treasury  most  of  the  common 
and  preferred  stock  of  the  Rock  Island  Company;  it  also 
had  the  right  to  issue  .$75,000,000  bonds.  It  now  of- 
ferred  for  each  share  of  the  railway  company's  stock,  one 
share  of  its  own  4  per  cent  bonds,  one  share  of  Rock 
Island  Company  coiimion  stock  and  $70  of  Rock  Island 
Company  preferred  stock.  These  bonds  were  to  be  col- 
lateral trust  secured  by  the  deposit  of  all  the  "railway" 
company  shares  obtained  by  the  "railroad"  company. 
Thus  the  "railway"  stockholders  would,  in  case  of  de- 
fault, get  back  exactly  the  stock  Mhich  they  had  ex- 
changed. 

The  "railway"  stockholders  readily  accepted  this 
proposition,  which  was  ecjuivalent  to  giving  a  large  stock 
dividend,  and  figured  that  even  if  they  retained  in  their 
own  hands  all  the  securities  which  they  received  by  the 
exchange  they  could  not  lose  and  might  benefit  by  the 
exchange.  If  they  did  not  care  to  retain  all  the  secur- 
ities they  received,  they  could  easily  dispose  of  their 
Rock  Island  common  and  preferred  shares  and  thus  get 
a  large  inmiediate  cash  payment. 

We  shall  understand  better  why  the  "Moore  crowd" 
desired  this  reorganization  if  we  examine  the  charter 
provisions  of  the  Rock  Island  Company.  One  of  the 
important  clauses  reads  as  follows: 

There  shall  be  five  classes  of  directors.  The  first  class  shall 
contain  a  majority  of  the  whole  number  of  the  directors  as  fixed 
at  any  time  by  the  by-laws.  The  holders  of  the  preferred  stock 
shall  have  the  right  to  the  exclusion  of  the  holders  of  the  com- 
mon stock  to  choose  directors  of  the  first  class. 


TYPICAL  REORGANIZATIONS 


497 


Thus  a  majority  of  the  Rock  Island  Company  preferred 
stock  could  elect  a  majority  of  the  board  of  directors  of 
that  company  and  this  board,  through  the  company's 
holdings  of  "railroad"  stock  could  completely  control  all 
the  affairs  of  the  Chicago,  Rock  Island  and  Pacific  Rail- 
way Company,  the  operating  company.  Now  the  out- 
standing preferred  stock  of  the  Rock  Island  Company 
is  only  a  little  over  $4.5,000,000;  therefore  the  owner- 
sliip  of  approximately  $22,.300,000  par  value  of  this 
preferred  stock  would  be  sufficient  to  give  complete  con- 
trol over  the  whole  Chicago  Rock  Island  and  Pacific 
Railway  Company,  having  a  total  capitalization  of  about 
$225,000,000.  Indeed,  if  this  $22,500,000  preferred 
stock  were  carried  on  a  margin  of  $20  a  share,  $5,400,- 
000  cash  would  suffice  to  secure  control. 

The  advantage  of  this  reorganization  to  the  "Moore 
crowd"  may  readily  be  seen  if  we  compare  the  price  they 
paid  for  control  in  the  "railway"  company  with  what  is 
necessary  for  control  in  the  Rock  Island  Company.  As- 
suming that  they  bought  all  their  stock  outright  and 
paid  in  the  neighborhod  of  140,  which  was  not  far  from 
the  average  market  price  while  they  were  buying  control 
of  the  "railway"  company,  their  investment  would  have 
heen  $52,500,140.  In  exchange  for  this  under  the  re- 
organization scheme  they  obtained  stock  and  bonds 
which  at  the  market  prices  of  the  early  part  of  1908  were 
worth : 


-7 

I 
I 


Rock  Island  Company  common $18,375,049 

Rock  Island  Company  preferred 21,918,808 

Chicago,  Rock  Island  &  Pacific  Railroad  Co. 

4%  bonds 32,766,712 

Total $73,069,569 

C— VI— 32 


498' 


CORPORATIOX  FINANCE 


'J  ■ 


As  the  preferred  stock  was  all  that  was  necessary  for 
control,  tiiey  were  left  free  to  sell  their  bonds  and  com- 
mon stock,  and  it  will  be  observed  that  this  sale  would 
have  brought  to  them  just  about  as  much  cash  as  they 
had  originally  paid  for  conti  il  of  the  Chicago  Rock 
Island  and  Pacific  Railway  Company.  In  other  words 
control  of  the  Rock  Island  ConipanV,  carrying  with  it 
control  of  both  subsidiary  companies',  cost  them  in  cash 
next  to  nothing. 

In  addition,  the  Rock  Island  Company  later  obtained 
control  of  another  great  railroad  system,  the  St.  Louis 
and  San  Francisco.  The  Rock  Island  directors  ac- 
complished  this  by  offering  to  exchange  for  each  share 
of  common  stock  of  the  St.  Louis  and  San  Francisco 
$60  par  value  in  the  common  stock  of  the  Rock  Island 
Company  and  $60  par  value  in  a  new  issue  of  .5  per  cent 
gold  bonds,  the  bonds  being  secured  by  deposit  of  the 
"Frisco"  common  stock  as  collateral. '  It  Avill  be  ob- 
served that  this  great  addition  to  the  Rock  Island  system 
did  not  disturb  in  any  way  the  controlling  force  of  a 
majority  of  the  relatively  small  issue  of  Rock  Island 
Company  preferred  stock.  Thus  by  reorganization  and 
purchase  the  "JMoore  crowd"  with  a  very  small  expendi- 
ture of  cash,  have  under  their  control  a  system  with  an 
aggregate  mileage  of  14,270  miles. 

276.  Westinghouse  reorganhation.— This  reorgani- 
zation of  1908,  although  not  essentially  different  in 
I)rinciple  from  the  Santa  Fe  reorganization,  introduces 
some  new  features  that  are  worthy  of  attention.  Owing 
to  space  limits  it  is  necessary  to  confine  our  attention  to 
these  peculiar  features. 

This  is  .1  typical  instance  of  a  company  which  was 
strong  in  equipment  and  ability  and  which" was  doing  a 
large  and  profitable  Imsiness  and  yet  suddenly  found 


i  ;il 


TYPICAL  REORGANIZATIONS 


499 


itself  technically  insolvent.  Its  difficulties  resulted  from 
a  lack  of  sufficient  working  capital.  The  company's 
assets  were  too  largely  fixed,  and  quick  assets  were  re- 
latively too  small,  considering  the  amount  and  char- 
acter of  the  company's  business.  In  prosperous  times 
the  company  was  able  to  prosper  with  the  rest  of  the 
country.  In  the  period  of  strain,  however,  it  was  very 
quickly  stripped  of  cash  and,  being  unable  to  obtain 
capital,  necessarily  went  to  the  wall. 

It  naturally  followed  that  the  most  active  and  influ- 
ential body  of  creditors  in  planning  the  reorganization 
were  merchandise  creditors;  next  to  them  came  the  bank 
creditors ;  the  bond  and  note  bolders  were  little  consulted 
and  their  claims  were  not  disturbed. 

The  problem  before  the  reorganizers  of  this  company 
differed  from  that  which  confronts  most  reorganizers 
ill  that  the  company  needed  simply  to  be  tided  over  a  bad 
I)cri()d.  Xo  one  apparently  felt  any  question  as  to  the 
renewed  prosperity  of  the  company  as  soon  as  normal 
business  conditions  should  be  restored.  The  permanent 
fixed  charges  were  met  even  during  the  period  of  re- 
organization. All  that  was  necessary,  therefore,  was  to 
take  care  of  the  floating  debt. 

The  main  elements  in  the  floating  debt  were  notes 
payable  to  banks,  $7,919,000,  and  merchandise  debts, 
•*'<4,762,000.  After  much  discussion  and  consideration 
of  two  or  three  plans,  the  merchandise  creditors,  through 
tlieir  committee,  finally  agreed  to  accept  new  common 
stock  of  the  company  at  par  in  full  settlement  of  their 
claims  on  certain  conditions  specified  below: 

(a)  Such  of  the  bank  debt  as  would  not  accept  new 
common  stock  to  be  provided  for  partly  by  convertible 
bonds  of  an  issue  already  authorized  previous  to  the 


I 


11 

i 


500 


CORPORATION  FINANCP: 


u 

I 


bankruptcy  and  partly  by  5  per  cent  notes  running  for 
an  average  period  of  5  years. 

(b)  The  existing  issues  of  convertible  bonds,  deben- 
ture certificates  and  collateral  notes  not  to  be  disturbed. 

(c)  The  preferred  and  common  stockholders  each  to 
pay  a  25  per  cent  assessment  in  cash. 

It  will  be  observed  that  none  of  the  sacrifices  under 
this  plan  were  to  be  made  by  the  bond  and  note  holders. 
Indeed,  it  would  have  been  impossible  to  impose  sacri- 
fices upon  these  classes  or  to  refuse  or  modify  their 
claims,  for  in  that  case  they  would  certainly  have  been 
prompt  to  bring  foreclosure  proceedings,  buy  the  prop- 
erty at  a  forced  sale  and  thus  reduce  the  unsecured 
claims  and  wipe  out  the  stockholders.  The  bond  and 
note  holders,  in  other  words,  were  in  an  impregnable 
position  because  the  company,  even  in  the  worst  times, 
was  more  than  earning  the  permanent  fixed  charges. 

The  bank  creditors  came  next  in  order  of  preference, 
and  their  only  loss,  therefore,  was  an  extension  of  time 
of  payment  of  their  obligations.  The  unsecured  credit- 
ors, knowing  the  weakness  of  their  position,  were  willing 
to  accept  stock  in  payment.  Under  the  circumstances 
it  was  both  expedient  and  just  that  the  stockholders 
should  be  called  on  for  particularly  heavy  assessment. 
It  was  expedient  because  the  prospects  of  the  company 
were  excellent  and  the  stock,  even  through  the  reorgan- 
ization, sold  at  fairly  good  prices.  The  stockholders, 
therefore,  could  well  afford  to  pay  this  assessment  rather 
than  forfeit  the  stock.  It  was  just  that  they  should  pay 
because  the  difficulties  of  the  company  could  have  been 
preventeu  if  less  had  been  paid  out  in  dividends  and 
more  cash  had  been  reserved  for  an  emergency.  Such 
protests  as  were  made  by  the  stockholders  for  these 


TYPICAL  REORGANIZATIONS 


501 


reasons  proved  unavailing  and  the  plan  as  outlined 
above  has  been  carried  into  effect. 

The  company  operating  under  this  plan  has  re- 
established itself  as  a  firm  and  prosperous  corporation. 
There  was  no  reason  to  fear  the  result.  The  plan  pro- 
vided for  all  the  floating  debt  incurred  uefore  the  re- 
organization, it  enlarged  only  very  slightly  the  fixed 
eharges  of  the  company,  and  it  introduced  new  and 
conservative  elements  into  the  management  of  the  com- 
pany. The  cash  working  capHal  on  hand  after  reor- 
ganization was  sufficient  for  the  needs  of  the  next  two 
years,  even  if  business  had  been  very  poor  indeed.  In 
addition  it  was  at  once  clearly  stated  on  good  authority 
that  dividends  on  the  new  common  stock  of  the  company 
would  not  be  paid  for  at  least  two  years,  thus  giving 
time  for  the  accumulation  of  a  substantial  surplus. 
These  drastic  measures  proved  effective  in  strengthen- 
ing the  con'oany's  financial  position  and  enabling  it  to 
fro  forward  steadily,  almost  as  if  no  setback  had  oc- 
curred. 


¥1 


CHAPTER  XXXII 

CANADIAN  REORGANIZATIONS 

277.  Canadian  rcorgankatims  and  sacrifice  of  secw 
rities.—Several  reorganizations  of  important  Canadian 
corporations  have  already  been  discussed  in  this  vohime 
Competent  financial  authorities,  both  in  Canada  and 
Great  Britian,  have  hinted  that  company  reorganiza- 
tions m  the  Dominion  have  been  too  numerous  and  that 
primary  financing  should  be  effected  with  such  monetary 
modesty  as  will  increase  the  safety  of  all  the  securities, 
especially  the  bonds.    Bondholders  and  shareholders  of 
several  corporations  have  undoubtedly  had  to  sacrifice 
a  considerable  portion  of  their  holdings  in  order  to  see 
proposed   reorgani::ation   schemes  effected.      Almost 
every  prominent  financial  visitor  from  Great  Britain 
from  whence  so  much  capital  is  obtained  for  Canada,' 
issues  a  warning  on  this  point  and  also  on  the  evils  of 
over-capitalization.     These  are  matters  which  demand 
the  serious  attention  of  Canadian  financiers. 

278.  Txco  Canadian  reorganizations.—We  may  brief- 
ly examine  the  reorganization  schemes  of  two  Canadian 
corporations.  The  Canadian  Cereal  and  Milling  Com- 
pany, which  at  one  time  was  a  part  of  the  International 
Milling  Company  of  Moose  Jaw,  found  it  necessary  to 
reorjranize  in  1912.  A  new  company,  the  Canadian 
Cereal  and  Flour  Mills,  Limited,  was  formed.  Addi- 
tional  working  capital  was  obtained  by  means  of  the 
issue  of  $250,000  seven  per  cent  cumulative  preferred 

502 


CANADIAN  REORGANIZATIONS 


503 


stock.    The  new  company  was  given  the  following  cap- 
italization: 

Stock  Authorized         Issued 

Preferred    $2,000,000     $    750,000 

Common   2,000,000  760,000 


$4,000,000     $1,600,000 

This  compares  with  $8,000,000  capital  of  the  old  com- 
pany, the  assets  of  which  have  now  been  transferred  in 
consideration  of  $500,000  preferred  shares  of  the  new 
company.  The  ordinary  shares  were  used  as  a  bonus 
to  the  imderwriters  in  consideration  of  their  taking 
$250,000  of  preferred  at  par. 

The  Dominion  Sawmills,  Limited,  a  merger  of  timber 
properties  of  British  Columbia,  was  reorganized  in  1912. 
The  company's  bonds  were  practically  all  held  in  Great 
Britain.  A  public  issue  of  £1,027,500  seven  per  cent 
participating  cumulative  preference  shares  at  97^  was 
made  in  the  London  market  in  July,  1911.  In  the 
scheme  of  capital  reconstruction  of  this  company  the  ex- 
isting six  per  cent  first  mortgage  debentures,  of  which 
there  were  outstanding  £930,000,  part  of  a  total  of 
£1,000,000,  were  exchanged  for  an  equivalent  amount 
of  five  per  cent  debenture  stock  in  the  new  company,  to 
be  known  as  the  United  Sawmills  and  Timber  Company, 
while  a  bonus  of  three  fully-paid  $1  shares  in  respect  of 
each  £20  of  debentures — say  fiften  per  cent — were  also 
allotted. 

The  $2,000,000  of  cumulative  seven  per  cent  partici- 
pating $100  preferred  shares  were  replaced  by  an  equiv- 
alent amount  of  six  per  cent  income  debenture  stock,  to- 
gether with  a  bonus  of  four  per  cent  in  fully-paid  $1 
shares  of  the  new  company.    The  $4,201,200  of  $100 


I 


504 


CORPORATION  FINANCE 


shares  exchanged  on  the  basis  of  six  new  fully-paid  $1 
shares  in  respect  of  every  $100  share  now  outstanding. 

The  capital  of  the  old  company  was  $5,000,000  seven 
per  cent  participating  cumulative  preference  shares, 
$5,000,000  ordinary  shares,  and  £1,000,000  six  per  cent 
first  mortgage  debenture  bonds. 

279.  Intricate  financing  of  a  reorganization. — One  of 
the  largest  and  most  important  reorganizations  in  Can- 
ada of  recent  years  was  effected  in  1913,  when  the  Span- 
ish River  Pulp  and  Paper  Mills,  Ijimited,  took  over  the 
Lake  Superior  Paper  Company,  Limited,  necessitating 
a  reconstruction  of  finances.  The  directors  and  share- 
holders of  the  Spanish  River  Company  approved  a  plan 
authorizing  the  acquisition  of  the  total  issued  capital 
stock  of  the  Lake  Superior  Paper  Company,  Limited, 
consisting  of  $3,000,000  in  preference  shares  and  $5,- 
000,000  in  common  shares. 

Spanish  River  shareholders  authorized  the  directors 
to  effect  an  agreement  between  the  company  and  a  sjti- 
dicate,  whereby  the  syndicate  agreed  to  deliver  to  the 
company  30,000  preference  shares  of  the  Lake  Superior 
Paper  Company  of  the  par  value  of  $3,000,000  and  50,- 
000  common  shares  of  the  par  value  of  $5,000,000  and 
to  pay  in  cash  to  the  company  the  sum  of  $900,000  in 
certain  fixed  instalments  in  consideration  of  the  issue 
to  the  syndicate  of  37,000  fully-paid  preference  shares 
of  the  company  of  the  par  value  of  $8,700,000  and  50,- 
000  fully-paid  common  shares  of  the  par  value  of  $5,- 
000,000,  and  the  guarantee  by  the  company  of  the  pay- 
ment of  the  principal  and  the  int(  rest  and  sinking  f mid 
upon  existing  issue  of  first  mortgage  bonds  of  the  Lake 
Superior  Paper  Company,  amoimting  to  $50,000,000. 

It  was  also  proposed  to  increase  the  capital  stock  of 
the  Spanish  River  Company  to  $20,000,000  by  the  crea- 


CANADIAN  REORGANIZATIONS  506 

tion  of  70,000  additional  preference  shares  and  60,000 
additional  common  shares.  Under  the  arrangement 
$900,000  cash  was  added  to  the  working  capital  of  the 
Spanish  River  Company. 

This  is  how  the  securities  of  the  Spanish  River  Com- 
pany stood  before  and  after  reconstruction.  In  1912, 
the  Spanish  River  Company  absorbed  the  Ontario  Pulp 
and  Paper  Company,  Limited. 

SECUKITIES  OF  THE  SPANISH   KIVER   PULP  AND  PAPEK  COMPANY, 
LIMITED,  BEFOEE  KECONSTBUCTION 

Authorized  Issued 

Bonds,  6% $2,500,000  $2,425,000 

Ontaria  Pulp 1,500,000  1,500,000 

Preferred   Stock  7% 8,000,000  8,000,000 

Common  Stock    4,000,000  3,000,000 

SECCEITIES   OF   THE   S    ANI8H   HIVEE   PULP   AND   PAPEK   COMPANY 
AFTER  RECONSTRUCTION 

Authorized         Issued 

6%  first  mortgage  bonds ^^'^^'T^ 

Redeemed  by  sinking  fund '^°'""" 

$2,425,000 

6%  bonds  of  Ontario  Pulp  and  Paper  ,  ,nn  noo 

^                 T  •    't.^  1.600,000       1,600,000 

Company,  Limited    •••      i.«w,www 

(Guaranteed  by   the   Spanish  River 

Pulp  and  Paper  Mills,  Limited) 

C%  bond.  I..k.  Superior  Pap,r  con.  ^ 

pany.  Limited    •  •  •      "'       ' 

(Guaranteed  by    the   Spanish  River 

Pulp  and  Paper  Mills,  Limited) 
7%  .„,.,uUtivc  partidp..i.g  prefer-  ^_^^^ 

coZoflU:::::::;:::::::.- .omm  s^m 


I 


50G 


CORPORATION  FINAxNCE 


The  preference  shares  issued  in  exchange  for  the  Lake 
Superior  Paper  Company  shares  were  not  to  carry  divi- 
dends until  after  July  1,  1014. 

The  total  fixed  assets  of  the  Spanish  River  Pulp  and 
Paper  Company,  including  the  Lake  Superior  Company 
plants,  but  excluding  all  timber  areas,  amount  to  ap- 
proximately $13,000,000,  while  the  total  mortgage  in- 
debtedness against  these  assets  consists  of  $8,925,000  six 
per  cent  first  mortgage  bonds.  The  surplus  of  current 
liquid  assets,  including  pulp  wood,  paper,  accounts,  and 
the  like,  over  and  above  current  liabilities,  after  deduct- 
ing the  additional  working  capital,  amounts  to  $2- 
100,000. 

The  company  financing  this  reorganization  made  an 
arangement  with  the  syndicate  from  which  the  Spanish 
River  Pulp  and  Paper  IMills,  Limited,  purchased  the 
shares  of  the  Lake  Superior  Paper  Company,  Limited, 
for  the  distribution  among  the  preference  and  common 
shareholders  of  the  Spanish  River  Pulp  and  Paper  Mills, 
Limited,  of  $000,000  of  the  common  stock  of  the  Span- 
ish River  Pulp  and  Paper  3Iills,  Limited,  received  by 
the  syndicate  on  the  sale  of  the  shares  of  the  Lake  Su- 
perior Paper  Company,  Limited.  Upon  this  distribu- 
tion, shareholders  received  a  bonus  amounting  r/ithont 
adjustment  of  fractions,  to  approximately  ten  per  cent 
of  their  holdings  of  the  preferred  stock  of  the  Spanish 
River  Pulp  and  Paper  Mils,  Limited,  and  to  twenty 
per  cent  of  their  holdings  of  common  stock  of  that  com- 
pany. 

280.  Further  financing.— Sm  further  financing  of 
this  somewhat  intricate  reorganization  is  explained  in 
the  following  quotations  from  letters  issued  by  the  sec- 
retary of  the  company  and  by  the  vice-president  and 
general  manager,  respectively: 


CANADIAN  REORGANIZATIONS 


507 


'% 


In  the  circular  issued  in  July  last  it  was  proposed  to  raise 
additional  working  capital  by  a  further  issue  of  preferred 
>Iiares,  but  this  plan  of  ^nancing  has  been  changed,  and  an  issue 
of  term  notes  submitted,  this  issue  providing  the  necessary 
capital  for  the  re(juirenients  of  the  company,  it  being  intended 
that  during  the  currency  of  these  notes,  no  dividends  on  the 
company's  capital  stock  should  be  declared  or  paid.  The  re- 
arrangement of  the  finances  of  the  joint  companies  has  been 
effected  by  large  financial  interests  in  London,  England,  who 
deem  it  advisable  to  reduce  the  number  of  the  board  of  directors 
to  seven. 

The  preparation  and  publication  of  the  report  have  had 
to  be  deferred  pending  a  settlement  of  the  basis  of  the  new  finan- 
cial arrangement  for  the  company.  These  have  now  been 
completed  and  will  take  the  form  of  an  issue  of  £300,000  of  term 
notes,  which  have  been  underwritten  at  95  by  the  London  finan- 
cial group,  consisting  of  Messrs.  Robert  Fleming  and  Co.,  the 
British,  Foreign  and  Colonial  Corporation  and  their  friends, 
the  Canadian  Agency,  Limited,  and  Messrs.  R.  Niveson  and 
Company. 

The  proceeds  of  this  issue  will  put  the  company  in  funds 
and  enable  its  operations  to  be  carried  on  successfully. 

281.  Financing  'which  raised  problems. — Another  im- 
portant reorganization  was  that  of  the  Canadian  Coal 
and  Coke  Company.  This  caused  considerable  criticism 
and  comment.  The  plan  of  reconstruction  called  for 
the  creation  of  an  issue  of  $4,000,000  seven  per  cent 
cumulative  preference  stock  of  the  holding  company 
which  was  to  be  offered  par  for  par  in  exchange  for 
Ixmds  both  of  the  Canadian  Coal  and  Coke  Company 
and  of  the  subsidiary  companies  then  in  the  hands  of  the 
public.  All  bonds  still  remaining  in  the  treasury  of  the 
liolding  company,  both  its  own  and  those  of  subsidiary 
companies  were  to  be  cancelled. 

In  a  letter  addressed  to  the  Iwrndholders  of  the  com- 


508 


CORPORATION  FINANCE 


panics    concerned,    the    secretary    of    each    of    them 
stated: 

The  companies  now  require  about  $1,500,000  to  pay  off  their 
existing  liabilities  and  to  carry  on  the  works  now  in  progress 
It  has  been  found  impossible,  in  the  prevailing  financial  con- 
ditions, to  obtain  the  necessary  funds  by  the  sale  of  bonds 
ranking  pari-passu  with   the  existing  issues.     The   work  in 
progress  has  recently  been  carried  out  on  the  personal  credit 
of  the  directors;  but  the  time  has  arrived  when  the  plan  above 
outlined  IS  rendered  absolutely  necessary.     This  plaa  will,  we 
believe,  protect  all  existing  investments  in  the  several  com- 
panies,  and  place  the  consolidated  company  in  a  position  to 
earn  and  pay  at  an  early  date  seven  per  cent  dividends  on  the 
cumulative  preference  stock  now  proposed  to  be  cr-ated. 

The  co-operation  of  all  the  bondholders  and  shareholders  of 
the  five  companies  is  earnestly  solicited  in  carrying  out  the 
proposed  plan  of  reorganization  and  consolidation. 

A  majority  of  the  bondholders  of  each  of  the  four  operat- 
ing companies  have  approved  of  the  plan  of  reorganization 
recommended  by  the  directors  of  the  several  companies. 

The  result  of  carrying  through  the  proposed  plan  will  be 
that  the  present  bondholders  will  have  a  preferred  claim  on 
the  earnings  of  the  company  for  their  investment  and  the  only 
charge  ranking  prior  to  the  preferred  shares  will  be  the  charge 
given  for  the  new  money  necessary  to  bring  the  combined  under- 
takings to  complete  success. 

The  same  letter  detailed  the  various  obstacles  and 
difficulties  encountered  by  the  companies  and  stated  the 
basis  of  the  transfer  of  the  subsidiary  companies  and  the 
reorcranization  and  consolidation  of  the  undertakings  of 
those  companies  in  the  Canadian  Coal  and  Coke  Com- 
pany, Limited,  as  follows: 

1.  That  the  holders  of  the  six  per  cent  mortgage  bonds 
of  the  five  above-named  companies  should  convert  the 
bonds  held  by  them,  on  the  basis  of  par  of  exchange,  into 


CANADIAN  REORGANIZATIONS 


509 


seven  per  cent  cumulative  participating  preference  stock 
of  Canadian  Coal  and  Coke  Company,  Limited. 

2.  That  for  the  purpose  of  effecting  this  conversion 
the  Canadian  Coal  and  Coke  Company,  Limited,  should 
create  $4,000,000  par  value  of  its  seven  per  cent  cumu- 
lative participating  preferred  stock. 

3.  That  all  the  properties  and  assets  of  the  companies, 
other  than  the  Canadian  Coal  and  Coke  Company,  Lim- 
ited, should  be  conveyed  to  and  vested  in  the  Canadian 
Coal  and  Coke  Company,  Limited,  freed  from  the 
charges  and  liens  created  by  the  outstanding  bonds  of 
the  respective  companies. 

4.  That  the  Canadian  Coal  and  Coke  Company,  Lim- 
ited, should  assume,  pay  and  perform  all  the  debts, 
liabilities  and  obligations  of  each  of  the  four  companies 
whose  properties  are  so  conveyed  to  it,  other  than  the 
liabilities  created  by  the  outstanding  bonds  of  those  com- 
panies. 

5.  That  the  Canadian  Coal  and  Coke  Company,  Lim- 
ited, should  issue  to  each  holder,  other  than  itself,  of  or- 
dinary shares  of  the  capital  stock  of  the  four  companies 
operating,  vi^hose  properties  are  so  conveyed  to  it,  fully- 
paid  ordinary  shares  of  the  capital  stock  of  the  Cana- 
dian Coal  and  Coke  Company,  Limited,  on  the  basis  of 
par  of  exchange. 

6.  The  entire  property  and  assets  of  all  the  four  oper- 
ating companies  would  then  be  vested  in  the  Canadian 
Coal  and  Coke  Company,  Limited,  free  from  any 
ciiarges  and  liens,  except  such  as  may  be  created  for  the 
purpose  of  liquidating  the  current  debts  and  liabilities 

if  the  five  companies  above  mentioned. 

282.  Question,  of  bondhohlerg'  majorily. — Much  criti- 
cism folowed  the  announcement  of  this  plan,  both  by  the 
Canadian  financial  press,  by  sections  of  the  investing 


() 


510 


CORPORATION  FINANCE 


public  and  by  some  holders  directly  interested.  The 
chief  bone  of  contention  appeared  to  be  that  a  bare  ma- 
jority of  the  company's  bondholders  could  cancel  the 
mortgage,  the  minority  having  to  submit  (although  the 
mortgage  was  common  to  all)  and  accept  the  proposed 
stock  issue.  Of  this  phase,  the  Montreal  Finan^nd 
Times  said : 

We  arc  entirely  out  of  sympathy  with  the  altogether  too 
prevalent  practice  among  Canadian  industrial  companies  of 
exchanging  bonds  for  secondary  securities  such  as  income  bonds 
or  preferred  stock  whenever  it  becomes  inconvenient  to  carry 
them  as  a  first  mortgage  claim  any  longer.  The  practice  of 
conversion  is  being  so  general  that  it  is  apparently  regarded 
as  a  matter  of  course  not  only  by  directors  and  "controlling  in- 
terests," but  by  the  investing  public.  If  the  thing  goes  on  much 
longer  it  will  be  impossible  to  issue  standard  bonds  in  Canada, 
or  at  least  to  have  them  accepted,  and  valued,  as  such  by  the 
investor,  for  it  is  becoming  a  recognized  thing  that  as  soon  as 
the  money  is  safe  in  the  treasury  and  the  bonds  are  nicely  dis- 
tributed and  the  underwriters  have  "got  from  under,"  the  mort- 
gage is  liable  to  be  torn  up  with  the  utmost  complacency  and 
the  supposed  mortgage-holders  to  find  themselves  put  off  with  a 
very  secondary  security. 

We  have  no  special  opinion  to  express  regarding  the  pres- 
ent re-financing  plans  of  the  Canadian  Coal  and  Coke  directors, 
the  latest  management  to  adopt  the  policy  to  which  we  take 
exception.  We  are  discussing  the  system  in  a  general  way. 
The  Canadian  Coal  and  Coke  Company  is  only  following  the 
prevailing  practice — taking  the  line  of  least  resistance,  tread- 
ing a  path  which  has  been  l>eaten  smooth  for  it  by  many  similar 
corporations.  But  we  do  hope  that  in  future  the  bondholders 
of  Canadian  industrial  corporations  will  see  to  it  that  they  arc 
getting  the  kind  of  protection  which  their  bonds  purport  to 
offer. 

283.  As  to  a  "hare  majoriti/."—Thls  stricture  brought 


CANADIAN  REORGANIZATIONS 


511 


a  reply  from  Mr.  C.  H.  Cahan,  K.C.,  a  distinguished 
Montreal  lawyer,  who  in  a  letter  to  the  same  paper, 
said: 

I  would  like  to  say  that  the  particular  clauses  of  that  deed 
which  you  describe  as  "a  flagrant  example"  are  drawn  in  form 
and  terms  approved  by  the  authorities  of  the  London  Stock 

Exchange. 

Palmer,  the  acknowledged  English  authority,  says  of  these 
provisions  that:  "Unless  the  majority  is  thus  enabled,  in  special 
circumstances,  to  determine  what  is  to  be  done  on  behalf  of 
the  whole  body,  the  minority,  however  small,  is  placed  in  a 
position  to  dictate  to  the  majority,  and  the  interests  of  the 
whole  of  the  majority  imperilled  by  the  ignorance,  perverse- 
ness,  fraud  or  cupidity  of  an  insignificant  minority,  or  the  de- 
lay which  would  result  if  it  were  necessary  to  obtain  the  con- 
sent of  every  debenture  holder." 

Palmer  adds  that  the  draftsman  who  omits  to  insert  some 
such  provision,  runs  the  risk  of  being  accused  of  neglecting 
the  best  interests  of  the  bondholders;  and  in  view  of  the  ab- 
sence in  Canada  of  a  comprehensive  insolvency  act,  and  of  the 
ixisting  state  of  our  law  respecting  the  voluntary  liquidation 
of  companies,  even  stronger  language  might  very  appropriate- 
ly be  applied  to  any  professional  draftsman  in  this  province 
who  would  exhibit,  by  such  omissions,  his  own  inexperience  or 

negligence. 

In  the  case  of  the  trust  deed  and  mortgage  of  the  Canadian 
Coal  and  Coke  Company,  Limited,  a  quorum  consisting  of  the 
holders  of  at  least  fifty  per  cent  of  the  par  value  of  the  bonds 
outstanding  must  be  present  at  the  meeting  of  the  bondholders, 
and  if  a  poll  is  demanded,  the  resolution  amending  the  pro- 
visions of  the  trust-.U-ed  and  mortgage  must  Ik-  passifl  by 
three-fourths  of  the  votes  given  on  such  poll.  Holders  of  over 
,,r^v-]mU  of  the  outstanding  bonds  may  defeat  the  proposed  pro- 
.Tcdings  by  merely  absenting  themselves  from  the  n.eeting;  and, 
in  any  case,  three  votes  must  be  polled  in  favor  of  the  resolu- 
tion to  every  single  vote  polled  against  it. 


512 


CORPORATION  FINANCE 


As  to  the  merits  of  the  reorganization  scheme  adopted  by 
the  Canadian  Coal  and  Coke  Company,  Limited,  and  by  its 
four  subsidiary  companies,  it  suffices  to  say  that  out  of  the 
several  millions  of  bonds  represented  at  the  four  meetings  of 
bondholders,  only  one  holder  of  $25,000  par  value  of  bonds 
polled  his  vote  against  the  scheme  proposed. 

I  may  add  that  the  trust  deed  and  mortgage,  above  re- 
ferred to,  was  not  drafted  by  me  and  that  I  have  written  the 
above  on  behalf  of  clients  who  are  large  holders  of  these  bonds, 
and  who  do  not  think  that  your  criticisms  are  well  founded  so 
far  as  they  were  applied  by  you  to  the  terms  of  the  trust-deed 
and  mortgages  of  the  Canadian  Coal  and  Coke  Company, 
Limited. 

The  financial  journal  in  printing  this  letter  replied 
with  the  f oUowmg  brief  comment : 

We  cannot,  however,  agree  with  Mr^Cahan  that  the  emi- 
nent English  authority,  Palmer?  whom  he  cites,  had  any  such 
conception  of  the  rights  of  majority  as  is  implied  in  the 
present  procedure  in  the  Canadian  Coal  and  Coke  Company, 
or  that  the  fact  that  only  one  bondholder  present  at  the  meet- 
ing last  week  voted  against  the  conversion  proposals,  is  any 
proof  that  those  proposals  were  in  the  interests  of  the  bond- 
holders as  a  whole. 

These  illustrations  show  the  numerous  phases  of  cor- 
poration reorganization  in  Canada.  It  is  also  seen  that 
a  keen  interest  is  taken  in  every  move  of  promoters  and 
financiers  in  that  coimtry.  So  far  as  the  Canadian  Coal 
and  Coke  reorganization  is  concerned,  the  company  was 
in  trouble,  and  it  is  difficult  to  see  how  they  could  have 
escaped  otherwise  than  they  did.  At  the  same  time,  the 
incident  raised  important  points  for  consideration  of  cor- 
poration financiers. 


QUIZ  QUESTIONS 

{The  numbers  refer  to  the  numbered  sections  in  the 

text.) 

CHAPTER  I 

1.  What  are  "non-stock"  corporations? 

2.  What  are  "stock"  corporations?    For  what  pur- 
pose are  they  usually  organized? 

3   What  is  the  most  striking  distinctive  feature  of 
the  corporation  compared  with  other  forms  of  business 

association? 

4.  In  what  sense  is  "corporate  entity    a  fiction? 

5.  In  what  nations  have  corporations  been  prominent 
features  of  business  life  ? 

6.  Show  briefly  how  the  use  of  corporations  has  spread 

in  recent  years.  .  . 

7.  State  how  and  why  the  corporate  form  is  well 
adapted  to  raising  large  amounts  of  capital. 

8  In  what  sense  is  a  corporation  more  permanent 
than  a  partnership  or  than  individual  proprietorship? 
IIow  is  this  attribute  an  advantage? 

9  Show  how  and  why  the  corporate  form  better 
lends  itself  to  an  efficient,  centralized  control  of  a  bus- 
iness than  the  partnership  form. 

10  Can  an  interest  in  a  corporation  be  more  readily 
transferred  from  one  person  to  another  than  an  mterest 
in  a  partnership?    Why? 

C— VI— 83  518 


5U 


CORPORATION  FINANCE 


11.  What  is  the  principle  of  limited  liability  of  cor- 
porate stockholders?  Is  the  principle  universally  ap- 
plicable? Name  the  principal  advantages  of  the  cor- 
porate form  of  organization. 

12.  Name  the  principal  disadvantages  of  the  cor- 
porate form.  Mention  two  kinds  of  enterprises  in 
which  these  disadvantages  outweigh  the  advantages. 


CHAPTER  II 


13.  What  are  the  legal  instruments  that  define  and 
control  a  corporation's  activities? 

14.  How  far  is  the  common  law  applicable  to  cor- 
porations ? 

15.  Is  it  important  to  consider  the  provisions  of  the 
constitution  of  the  state  in  which  a  corporation  is 
formed  ?    "Wliy  ? 

16.  Discuss  the  relative  advantages  of  two  methods 
of  securing  „  ^thority  to  incorporate. 

17.  Wliat  is  a  charter?  What  is  a  certificate  of  in- 
corporation? What  are  articles  of  incorporation?  What 
information  should  a  charter  ordinarily  contain? 

18.  Draw  up  a  charter  for  a  company  (imaginary  or 
otherwise)  following  the  model  given  in  the  text. 

19.  Can  a  new  corporation  assume  a  name  which  has 
already  been  adopted  by  a  corporation  chartered  in  some 
other  state?  Do  any  of  the  states  prescribe  "ny  part 
of  the  names  of  corporations  organized  under  their 
laws? 

20.  Why  is  it  important  to  state  the  purposes  for 
which  a  company  is  formed  fully  and  carefully  in  the 
charter?    Why  did  the  New  Jersey  Court  of  Errors 


QUIZ  QUESTIONS 


515 


and  Appeals  hand  down  a  decision  adverse  to  the  rail- 
road company  in  the  instance  cited  in  the  text? 

21.  What  is  the  minimum  number  of  incorporators 
in  most  states? 

22.  What  topics  are  usually  considered  in  the  by- 
laws of  a  corporation?  Draw  up  a  brief  set  of  by-laws 
for  a  company  (imaginary  or  otherwise)  following  the 
model  given  in  the  text. 

23.  What  are  the  usual  by-law  provisions  as  to  stock, 
meetings,  officers,  dividend  payments  and  by-law 
amendments  ?  How  may  new  rules  of  action  be  adopted 
without  the  formality  of  amending  the  by-laws? 


^ 


\\ 


CHAPTER  III 


24.  What  are  the  four  fundamental  rights  of  the 
body  of  stockholders  of  a  corporation?  May  a  board 
of  directors  ordinarily  sell  the  assets  of  their  corpora- 
tion without  the  consent  of  the  stockholders? 

25.  Name  the  four  fundamental  rights  of  each  in- 
dividual stockholder.  What  is  a  proxy?  Write  a  proxy 
conferring  the  right  to  vote  in  favor  of  a  proposed 
amendment  at  a  special  meeting  called  for  the  purpose 
of  considering  the  amendment.  When  is  a  proxy  irre- 
vocable? 

26.  Can  stockholders  force  a  board  of  directors  to 
declare  a  dividend,  provided  the  company  is  admitted 
to  have  earned  large  profits?  What  is  meant  by  the 
"right  to  dividends"? 

27.  Does  a  stockholder  have  a  legal  right  to  inspect 
the  books  of  his  company?  How  does  the  movement 
in  favor  of  publicity  of  accounts  work  in  favor  of 
stockholders? 


516 


CORPORATION  FINANCE 


28.  What  are  the  two  chief  universal  liabilities  of 
stockholders  ? 

29.  What  are  the  two  classes  of  creditors  ?  Has  either 
class  a  right  to  interfere  in  the  internal  management 
of  the  debtor  corporation? 

30.  What  are  "dummy"  directors?  How  are  they 
sometimes  kept  under  control? 

31.  What  in  general  are  the  powers  of  a  board  of 
directors?  May  those  powers  be  delegated?  Under 
what  circumstances  do  directors  become  liable  for  loss 
suffered  by  their  corporation? 

32.  Why  is  it  stated  in  the  text  that  the  corporate 
form  is  "almost  ideally  adapted,  so  far  as  efficiency  and 
economy  go,  to  the  conditions  of  present-day  industry"? 


CHAPTER  IV 


33.  By  virtue  of  what  legal  principle  do  corpora- 
tions chartered  in  one  state  of  the  Union  extend  their 
operations  to  other  states?  Give  the  gist  of  the  de- 
cision of  the  Supreme  Court  in  the  case  of  The  Bank 
of  Augusta  vs.  Earle. 

34.  May  a  state  regulate  in  any  manner  corporations 
doing  business  within  its  borders,  but  chartered  in  an- 
other state?    If  so,  how? 

35.  Give  three  reasons  in  favor  of  securing  a  charter 
from  the  state  in  which  a  corporation  has  its  principal 
office.    Why  are  not  these  reasons  decisive  in  all  eases? 

36.  From  the  tables  given  in  the  text  estimate  the 
organization  fees  and  the  annual  franchise  taxes  of  a 
corporation  with  $50,000  capital  stock  in  New  Jersey, 
New  York,  Delaware,  Maine  and  South  Dakota.  What 


QUIZ  QUESTIONS 


617 


other  expenses  will  probably  be  incurred  in  starting  a 

new  company? 

37.  Name  four  states  which  have  liberal  incorpora- 
tion laws. 

38.  Why  is  it  desirable  to  secure  a  charter  in  a  state 
which  has  an  established  and  well-adjudicated  corpora- 
tion law? 

39.  Name  three  states  which  bear  poor  reputations  as 
states  of  incorporation.  Name  three  states  which  bear 
good  reputations. 

40.  If  you  were  about  to  incorporate  a  manufactur- 
ing company,  located  in  Massachusetts,  designed  both 
to  operate  a  plant  and  to  buy  up  the  scock  of  several 
competing  companies,  the  capitalization  to  be  $2,000,- 
000,  in  what  state  would  you  take  out  a  charter?  What 
other  states  would  you  be  inclined  to  consider  favorably? 
Base  your  answer  on  the  data  given  in  the  text  and 
state  your  reasons  fully.  An  excellent  method  of  get- 
ting familiar  with  the  main  features  of  the  various 
state  laws  is  to  make  up  a  number  of  simUar  hypothetical 
cases  and  consider  each  one  carefully. 

41.  What  is  a  "subscription  contract'*  ana  when  is 

it  used? 

42.  What  is  meant  by  the  statement  that  a  capable 
lawyer  can  generally  fit  out  any  corporation  with  the 
exact  powers  and  privileges  that  will  prove  most  ad- 
vantageous. .  . 

43.  Discuss  the  Companies'  Act  of  the  Dommion. 
How  is  a  charter  forfeited?  What  are  the  provisions 
of  the  Companies'  Act  in  regard  to  liability  of  share- 
holders? What  are  the  powers  and  limitations  of  the 
directorate  under  this  act?  .        * 

44.  What  conditions  complicate  the  incorporation  of 

companies  in  Canada? 


518 


CORPORATION  FINANCE 


CHAPTER  V 

45.  In  your  opinion  should  stock  certificates  be  maJe 
fully  negotiable?    Give  your  reasons  in  full. 

46.  What  is  the  "par  value"  of  a  share  of  stock?  The 
"market  value"?  Is  there  any  good  reason  for  the 
custom  of  giving  shares  a  nominal  value  in  money? 

47.  Define  fully  "preferred  stock,"  showing  wherein 
the  preference  may  consist. 

48.  Name  and  discuss  four  uses  of  preferred  stock. 
What  is  "voting  stock"? 

49.  What  is  the  object  of  "cumulative  voting"?  How 
is  that  object  attained? 

50.  What  is  a  "voting  trust"?  What  is  the  usual 
plan  of  organization?  What  is  the  usual  object  in 
establishing  a  voting  trust? 

51.  Describe  the  formation  of  the  Dominion  Sttji 
and  Coal  Corporation,  Ltd.  In  your  opinion  was  this 
the  best  way  to  settle  the  trouble  between  the  two  orig- 
inal companies? 


CHAPTER  VI 


52.  Define  "quasi-public  corporations,"  "private  cor- 
porations," "close  corporations." 

58.  What  is  a  "parent  company"?  ^Vllat  is  the  dif- 
ference between  a  "parent  company"  and  a  "holding 
company"? 

54.  Why  does  a  holding  company  usually  aim  to  se- 
cure more  than  a  bare  majority  of  the  stwk  of  its  subsid- 
iary companies?  What  is  the  distinction  between  the 
ordinary  balance-sheet  of  a  holding  company  and  its 
"consolidated"  or  "general"  balance  sheet? 


QUIZ  QUESTIONS 


519 


55.  Under  what  plan  were  the  early  "trusts"  or- 
^ranized?  Why  do  most  "trusts,"  so-called,  now  take 
t\ie  form  of  holding  companies? 

5(5  Taking  the  chart  of  organization  of  the  Inter- 
horough-^letropolitan  Company,  show  what  relation  of 
ownership  and  control  exists  between  the  New  York 
City  Railway  Company  and  the  Interborough-Metro- 

politan  Company.  i,  j  u 

57  How  many  companies  are  directly  controlled  by 
the  Standard  Oil  Company  of  New  Jersey  ?  How  many 
indirectly? 


CHAPTER  VII 

58.  Enumerate  from  memory  the  principal  topics 
covered  in  the  first  six  chapters  of  this  book. 

59.  What  are  the  six  sources  of  corporate  funds?  In 
what  sense  may  profits  be  called  a  possible  source  of 
funds?  In  what  sense  do  trade  creditors  supply  cor- 
porate funds?  Can  a  corporation  manager  or  promoter 
ordinarily  sell  the  stock  or  bonds  of  his  company  to  a 
bank?    If  not,  why  not? 

60.  What  are  the  important  classes  of  mvestorsf 

61.  How  would  you  distinguish  between  an  "invest- 
ment" and  a  "speculative"  security? 

62.  What  are  the  important  classes  of  buyers  of 
speculative  securities? 

63  Why  is  it  desirable  that  a  corporation  should 
borrow  a  considerable  proportion  of  its  funds?  What 
proportion  of  the  funds  used  by  the  five  companies 
named  in  the  text  are  borrowed? 

64.  What  kinds  of  securities  ordinarily  will  a  cor- 
l)()ration  offer  in  order  to  secure  funds  from  (a)  trade 


520 


CORPORATION  FINANCE 


creditors,  (b)  banks,  (c)  the  investing  public,  and  (d) 
the  speculative  public^  Name  and  describe  the  six  im- 
portant groups  of  corporate  assets.  What  securities 
may  be  issued  corresponding  to  each  group?  In  deter- 
mining what  securities  a  corporation  may  "jsue,  are  the 
earnings  of  the  corporation,  as  well  as  its  /issets,  taken 
into  consideration ?     If  so,  how  i 

05.  What  proportion  of  the  corporate  capitalization 
for  the  year  mentioned  in  the  text  is  invested  in  corpo- 
rations capitalized  at  more  than  a  million  dollars? 

66.  What  is  the  Canadian  attitude  toward  the  par- 
ticipation of  banks  in  the  flotation  of  security  issues? 
What  is  the  position  of  the  bank  if  the  flotation  is  suc- 
cessful?    Unsuccessful? 

67.  How  does  a  Canadian  bank  make  loans  to  cor- 
porations? 

68.  What  conditions  make  it  comparatively  safe  for  a 
Canadian  bank  to  make  lai^je  loans  to  corporations? 


CHAPTER  VIII 


69.  How  are  corporate  funds  secured  from  trade 
creditors?  What  two  qualifications  limit  the  general 
statement  that  a  corporation  should  buy  as  much  as  it 
can  on  credit?  What  is  a  conservative  percentage  of 
accounts,  bills  and  notes  payable  to  quick  assets? 

70.  What  are  the  main  points  that  will  be  considered 
by  a  careful  banker  in  determining  how  much  credit  he 
is  willing  to  extend  to  a  corporation? 

71.  What  are  the  essential  features  of  a  valid  nego- 
tiable promissory  note?  What  is  the  chief  objection 
to  using  short  or  medium  term  notes  sold  to  the  public 
as  a  means  of  securing  corporate  ftmds?    Under  what 


QUIZ  QUESTIONS 


521 


circumstances  is  it  good  financial  policy  for  a  corpo- 
ration to  issue  such  notes?  In  general  should  the  short- 
lime  obligations  of  a  corporation  ever  be  based  on  the 
corporation's  permanent  assets? 

72  Under  what  conditions  are  short-term  notes  a  de- 
sirable means  of  securing  money?  What  sort  of  corpo- 
rations use  this  method  of  raising  money? 

78.  Describe  the  short-term  loan  made  by  the  Ca- 
nadian Northern  Railway  Co.  ,      ,        ^         j 

74.  What  is  the  attitude  of  Canadian  bankers  toward 

short-term  notes?    TV'iy? 

75.  Discuss  the  problems  created  by  short-term  loans. 

CHAPTER  IX 

76  What  three  opinions  are  prevalent  as  to  the  chief 
factor  that  determines  the  value  of  fixed  assets? 

77  What  are  the  characteristic  features  of  a  mort- 
gage?   What  is  a  mortgage  bond?    What  is  a  mort- 

irage  deed  of  trust?  .  .  , 

78.  What  are  the  essential  and  usual  provisions  of 

a  corporate  deed  of  trust? 

79.  Define  "closed."  "open-end"  and  "limited  open- 
end"  mortgage  deeds  of  trust.  Which  of  the  three 
types  is  generally  the  best?    Why? 


CHAPTER  X 

80.  Give  from  memory  the  principal  descriptive 
words  applied  to  corporate  bonds  indicating  (a)  their 
security,  (b)  their  purposes,  (c)  their  manner  of  pay- 
ment  and  (d)  their  conditions  of  redemption. 


522 


CORPORATION  FINANCE 


81.  What  is  a  junior  mortgage  bond?  How  is  the 
fact  that  it  is  a  junior  bond  sometimes  disguised? 

82.  What  are  sinking  fund  bonds?  What  are  the 
principal  objections  to  tiieir  use? 

83.  What  are  collateral  trust  bonds?  Why  may  they 
sometimes  be  sold  more  readily  than  the  securities  on 
which  they  are  directly  based  ?  H<  may  they  be  used 
to  finance  the  process  of  buying  control  of  subsidiary 
corporations  ? 

84.  What  is  an  equipment  trust  bond?  Why  are  they 
so  highly  regarded  by  investors? 

85.  In  what  way  does  the  Grand  Trunk  Railway 
short-term  loan  of  July,  1913,  resemble  an  issue  of 
equipment  notes? 

CHAPTER  XI 

86.  Compare  English  with  American  practice  with 
reference  to  the  use  of  debenture  bonds.  What  reasons 
lead  to  the  issue  of  debenture  bonds  from  time  to  time 
by  some  corporations  in  this  country? 

87.  What  are  income  bonds?  What  is  the  chief  ob- 
jection to  their  use? 

88.  Define  "participating,"  "profit  sharing"  and 
"joint"  bonds  and  "receiver's  certificates." 

89.  What  are  registered  bonds?  Coupon  bonds? 
What  are  the  advantages  and  disadvantages  of  each 
form?     \Vhat  are  redeemable  bonds? 

90.  What  are  convertible  bonds?  What  are  their 
advantages  and  disadvantages  to  the  corporation? 


CHAPTER  XII 

91.     "What  is  a  promoter?    Does  he  have  a  legitimate 
and  useful  function  or  m.t'    Give  your  reasons. 


QUIZ  QUESTIONS 


523 


92.  What  is  meant  by  the  promoter's  "discovery"  of 

...proposition?     Illustrate  in  detail  with  reference  to 

Jme  hypothetical  case,  such  as  a  new  gold  mme  in 

Alaska  or  a  proposed  creamery  in  a  small  country  town. 

93.  What  is  meant  by  "assembling"  a  proposition? 
Illustrate  in  detail  with  reference  to  the  same  hypo- 
tlietical  case  used  in  the  previous  question. 

94.  What  are  the  first  steps  in  financing  a  proposi- 
tion? What  is  the  advantage  of  carrying  the  develop- 
ment of  the  proposition  as  far  as  practicable  before 
asking  outsiders  to  supply  funds? 

95  Why  should  a  promoter  usually  endeavor  to 
raise  more  money  in  advance  of  complete  development 
of  a  proposition  than  he  expects  will  be  needed? 

96  Why  is  it  usually  better  for  a  promoter  to  se 
to  a  large  number  of  small  buyers  than  to  a  small 
number  of  large  buyers? 

97.  To  whom  should  a  promoter  go  first,  generally 

speaking,  for  funds?    Why? 

98.  Show  how  the  principles  of  promotion  laid  down 
are  applied  in  the  illustration  given  in  the  text. 

CHAPTER  XIII 

99.  Why  are  professional  promoters  usually  unsuc- 
cessful in  the  long  run? 

100.  Why  do  lawyers  and  bankers  in  small  communi- 
ties do  a  considerable  amount  of  promotion  work?  To 
what  extent  do  the  large  metropolitan  bankers  and 
promoters  enter  the  field  of  promotion  ? 

101.  What  are  the  advantages  of  engineermg  firms 

us  promoters?  . 

102.  Is  a  promoter  in  any  sense  an  agent  of  his  cor- 
poration?   A  promoter  buys  a  manufacturing  plant  for 


524 


CORPORATION  FINANCE 


•$10,000  and  sells  it  to  a  corporation  which  he  promotes 
for  $20,000,  representing  this  latter  sum  to  be  the  price 
he  paid  for  the  plant:  is  he  legally  entitled  to  his  $10,00^ 
profits?  If  not,  what  course  may  he  pursue  in  order  to 
evade  the  law  ? 

103.  Why  is  it  difficult  to  enforce  the  principle  that 
misleading  statements  by  a  promoter  are  fraudulent? 

104.  A  promoter  makes  a  contract  on  behalf  of  his 
corporation  which  is  not  yet  formed:  how  may  the  cor- 
poration become  bound  by  this  contract  without  for- 
mally ratifying  it? 

105.  How  did  the  promoters  of  the  Rubber  Goods 
Manufacturing  Company  receive  their  pay?  Of  the 
American  Smelting  and  Refining  Company?  In  gen- 
eral what  two  plans  of  determining  a  promoter's  profits 
are  most  commonly  used? 

106.  What  are  the  chief  risks  and  tasks  that  a  pro- 
moter must  generally  assume? 

107.  Do  you  think  that  promoters  in  general  are  or 
are  not  overpaid?    Give  your  reasons. 

CHAPTER  XIV 

108.  Why  is  there  a  strong  tendency  toward  consol- 
idation among  small  as  well  as  among  large  industrial 
establishments? 

109.  What  are  the  principal  difficulties  that  are  apt 
to  confront  a  promoter  who  undertakes  to  consolidate 
several  existing  concerns? 

110.  Describe  briefly  the  process  of  "discovering"  a 
consolidation. 

111.  What  is  the  usual  method  of  "assembling"  a  con- 
solidation? What  is  a  "basis  of  consolidation"?  What 
are  the  characteristic  features  of  the  two  agreements 
cited  in  the  text? 


QUIZ  QUESTIONS 


525 


112.  Why  is  it  important  for  the  promoter  of  a  con- 
solidation to  consider  with  especial  care  the  means  of 
•providing  his  new  corporation  at  the  outset  with  suffi- 
cient cash  ? 

113.  Why  does  the  promoter  of  a  consolidation  gen- 
erally try  to  raise  cash  by  means  of  a  bond  issue?  How 
may  he  manage  to  dispose  of  bonds  issued  by  a  new 
corporation  with  small  or  uncertain  assets? 

114.  How  does  the  problem  of  forming  a  large  con- 
solidation differ  from  the  problem  of  forming  a  small 
consolidation? 

115.  What  is  the  usual  basis  of  consolidation  or  ex- 
change and  how  is  it  determined? 

110.  What  was  the  basis  of  exchange  in  the  forma- 
tion of  the  Interborough-Metropolitan  Company?  In 
what  respects  was  it  faulty? 

117.  What  has  been  Canada's  experience  in  forming 
consolidations?  What  are  the  advantages  of  consolida- 
tions in  Canada  as  cited  by  the  promoters? 

118.  Wliat  is  the  basis  of  consolidations  ordinarily? 
Describe  some  prominent  amalgamations. 

119.  How  are  stocks  watered  in  forming  a  consolida- 
tion? 

120.  What  has  been  the  usual  result  in  the  reorgan- 
ization of  overcapitalized  industrial  consolidations  in 
Canada? 

121.  Describe  the  formation  of  the  Canada  Transpor- 
tation Lines,  Ltd.  Were  the  Canadian  promoters  well 
paid  for  their  share  in  this  consolidation? 

CHAPTER  XV 

122.  What  were  the  conditions  under  which  the  steel 
business  of  the  United  States  was  conducted  in  the 
decade,  1890-1900? 


1! 


526 


CORPORATION  FINANCE 


123.  What  were  the  chief  steel  companies  in  the  field 
in  1901  and  why  had  most  of  them  been  formed  in  tkic 
three  years,  1898-1901?  \ 

124.  What  is  meant  by  "integration"  of  an  industry? 
How  did  this  factor  operate  to  bring  about  the  forma- 
tion of  a  great  steel  combination? 

125.  Why  was  not  the  promotion  of  the  United  States 
Steel  Corporation  an  especially  difficult  task?  Why 
were  the  four  Moore  companies  included  in  the  com- 
bination? What  was  the  original  capitalization  of  the 
United  States  Steel  Corporation? 

126.  Was  the  prospectus  issued  by  the  promoting 
syndicate  misleading?  How  much  cash  did  the  syn- 
dicate furnish? 

127.  What  were  the  approximate  profits  of  the  pro- 
moting syndicate? 

128.  What  percentage  of  the  stock  of  the  underlying 
companies  was  secured  by  the  Steel  Corporation?  Give 
from  memory  a  list  of  some  of  the  important  assets  of 
the  corporation. 

129.  What  have  been  the  principal  additions  to  the 
Steel  Corporation?  Give  briefly  the  terms  of  the  Hill 
ore  lease  and  of  the  Tennessee  Coal,  Iron  and  Railroad 
Company  deal.  What  is  the  approximate  cost  of  the 
steel  rail  mill  at  Gary,  Indiana? 

130.  Describe  briefly  the  preferred  stock  conversion 
plan  of  1002.  What  objections  were  raised  to  the  plan? 
What  important  changes  in  the  interior  financial  or- 
ganization of  the  corporation  have  been  made? 

131.  Give  briefly  the  argument  tending  to  show  that 
the  Steel  Corporation  is  greatly  over-capitalized.  Give 
briefly  the  argument  on  the  other  side  of  the  question. 

182.  What  in  general  is  the  policy  of  the  Steel  Cor- 


QUIZ  QUESTIONS 


IS27 


poration  toward  its  employes?    Do  the  subsidiary  com- 
oanies  of  the  corporation  compete  with  each  other? 

133.  What  are  the  principal  outstanding  securities 
of  the  Steel  Corporation?  What  reasons  may  be  given 
for  expecting  that  these  securities  over  a  period  of 
years  will  rise  in  value  ? 


CHAPTER  XVI 


134.  Name  the  four  methods  of  selling  corporate 
securities. 

135.  What  are  the  characteristics  of  a  good  prospec- 
tus? Why  are  statements  in  speculative  prospectuses 
usually  vague? 

136.  Show  that  the  characteristic  features  of  specula- 
tive prospectuses  are  present  in  the  example  cited  in 
the  text. 

137.  What  are  the  characteristics  of  strictly  invest- 
ment prospectuses?  Is  it  safe  to  assume  that  these 
characteristics  are  never  apparent  except  when  the  se- 
curity offered  is  of  the  highest  grade? 

188.  What  would  be  the  characteristics  of  an  ideal 
prospectus? 

139.  What  are  the  advantages  and  disadvantages  to 
a  corporation  of  selling  its  securities  through  large  bond 
and  banking  houses  ? 

140.  What  are  the  characteristics  of  large,  high-class 
hanking  houses  in  contrast  to  disreputable  concerns  and 
what  are  *he  essential  factors  that  make  a  proposition 
acceptable  to  them  ? 

141.  ^Vhat  are  the  usual  banking  house  methods  of 
selling  securJ^-es?  Do  such  houses  guarantee  the  safety 
of  tne  securities  thev  sell  ? 


) 


528 


CORPORATION  FINANCE 


142.  Where  is  the  big  market  for  Canadian  securities? 

143.  Why  is  it  important  that  the  British  investor  ha 
given  full  and  correct  information? 

144.  What  information  should  be  jiven  in  the  pros- 
pectus? 

145.  What  is  the  tendency  of  the  United  States  mar- 
ket for  Canadian  securities?    Why? 

146.  Which  is  Canada's  richest  rural  community? 
What  is  its  principal  rural  industry?  How  has  it  been 
financed? 

CHAPTER  XVII 


147.  Name  the  principal  stock  exchanges  of  the 
United  States. 

148.  What  percentage  of  the  securities  handled  on 
the  New  York  Stock  Exchange  are  "listed"?  What 
are  the  requirements  for  listing? 

149.  Wliat  is  the  "curb"  market  and  what  classes  of 
securities  are  bought  and  sold  in  this  market? 

150.  Describe  briefly  the  method  of  handling  trans- 
actions on  the  floor  of  a  stock  exchange. 

151.  What  is  the  relative  importance  of  speculative 
as  compared  with  investment  business,  and  what  func- 
tion is  performed  by  the  speculative  business? 

152.  Describe  the  process  of  buying  securities  "on 
margin." 

153.  Describe  the  process  of  selling  securities  "short." 

154.  What  are  the  characteristics  of  stock  exchange 
houses  in  contrast  to  "bucket  shops"? 

155.  Into  what  three  classes  may  Wall  Street  specu- 
lators be  divided? 

156.  Give  from  memory  a  brief  review  of  the  char- 
acteristics of  the  Wall  Street  security  market. 


QUIZ  QUESTIONS 


529 


157.  What  measures  may  be  taken  to  stimulate 
speculative  interest  in  a  security  that  is  about  to  be 
issued  ? 

158.  With  what  object  is  a  syndicate  frequently 
formed  to  assist  in  the  flotation  of  a  security? 

159.  By  the  use  of  what  methods  may  the  price  of 
a  stock  market  security  be  manipulated  and  kept  under 
control  ? 


CHAPTER  XVIII 

160.  What  is  underwriting?  How  did  the  practice 
and  the  word  originate? 

161.  What  are  the  chief  advantages  to  the  corpora- 
tion in  having  its  new  issues  underwritten? 

162.  What  are  the  advantages  to  the  buyers  of  se- 
curities J 

163.  When  is  underwriting  inadvisable?  What  is 
your  opinion  as  to  the  merits  of  the  Pennsylvania  Rail- 
road controversy  referred  to  in  the  text?  Give  your 
reasons. 

164.  Why  do  the  underwriting  houses  in  almost  every 
case  band  themselves  together  into  syndicates? 

165.  Describe  three  types  of  syndicates. 

166.  Describe  the  type  of  syndicate  in  which  the  sale 
of  the  security  is  pooled. 

167.  Describe  the  type  of  syndicate  in  which  the  un- 
derwritten issue  is  distributed  among  the  members  of 
the  syndicate. 

168.  Name  some  of  the  principal  underwriting 
houses.  What  is  the  distinction  between  a  bank  and  a 
l)anking  house? 

C— VI— 34 


fiSO 


CORPORATION  FINANCE 


CHAPTER  XIX 


C 


169.  Why  are  underwriting  syndicate  agreements 
frequently  quite  informal  ? 

170.  Make  an  abstract  showing  the  principal  points 
covered  in  the  agreement  of  the  syndicate  formed  to 
underwrite  the  preferred  stock  conversion  of  the  United 
States  Steel  Corporation. 

171.  Mention  two  general  characteristics  of  under- 
writing agreements. 

172.  With  what  three  classes  of  corporations  do  un- 
derwriting syndicates  deal? 

173.  AVhat  are  the  peculiar  problems  and  difficulties 
involved  in  underw  riling  the  security  issues  of  new  or 
speculative  corporations? 

174.  Review  from  memory  the  example  of  specula- 
tive underwriting  given  in  the  text  and  make  sure  that 
you  understand  thoroughly  all  the  operations  involved. 
What  conditions  made  possible  the  construction  of  a 
new  plant  in  this  case  wholly  with  borr(,\v.id  funds? 
What  principles  followed  in  this  case  are  applicable  in 
all  cases  where  it  is  desired  that  an  imdeveloped  corpo- 
ration should  borrow  as  much  as  possible? 


CHAPTER  XX 

175.  What  mistake  is  frecjuently  made  in  the  invest- 
ment of  the  original  capital  funds  of  a  corporation? 

170.  What  are  the  advantages  of  the  installment 
method  of  getting  funds  for  a  corporation  only  as  the 
funds  are  needed? 

177.  AAHiat  are  the  disadvantages  of  this  method? 


QUIZ  QUESTIONS 


581 


178.  What  are  the  other  possible  methods  of  getting 
cash  as  needed,  when  the  total  amount  necessary  cannot 
be  accurately  foreseen? 

179.  What  considerations  determine  how  large  an 
amount  must  be  invested  by  a  corporation  in  fixed  cap- 
ital?   What  is  working  capital? 

180.  What  are  the  four  forms  which  working  capital 
may  take? 

181.  What  factors  determine  how  large  an  amount 
of  working  capital  should  be  carried  by  a  corporation? 

182.  Of  the  companies  named  in  the  text,  which  one 
has  the  largest  percentage  of  working  capital  to  gross 
business?     Can  you  suggest  any  reason? 

183.  What  are  the  five  factors  that  immediately  affect 
working  capital  and  determine  its  amount?  Why  do 
railroads  require  only  a  small  proportion  of  working 
capital  ? 

184.  About  how  much  working  capital  did  the  Penn- 
sylvania Railroad  Company  carry  in  1908?  Why  was 
this  amount  greater  than  that  carried  bv  most  railroad 
companies? 

185.  Why  is  it  of  the  utmost  importance  that  a  cor- 
poration should  be  supplied  with  the  proper  amount  of 
working  capital? 


CHAPTER  XXI 


186.  Draw  up  from  memory  a  model  corporate  in- 
come statement,  arranging  the  items  in  their  proper 
order. 

187.  By  what  common  methods  may  a  company's 
statement  of  gross  earnings  be  padded? 

188.  What  expenditures  and  what  reserves  should 


r>32 


CORPORATION  FINANCE 


always  be  included  under  the  head  of  operating  ex- 
penses ? 

189.  What  are  the  causes  of  depreciation?  What  is 
a  depreciation  reserve?  What  method  of  allowing  for 
depreciation  has  been  in  common  use  among  steam  and 
electric  railroad  companies?  Is  a  depreciation  reserve 
usually  set  aside  as  a  separate  sum  to  be  invested  outside 
the  corporate  business  ? 

190.  Why  should  "income  from  other  sources"  be 

* 

stated  separately?     Why  should  cumulative  preferred 
dividends  be  paid  regularly,  if  practicable? 

191.  Should  a  corporation  ordinarily  pay  out  all  its 
profits  in  the  form  of  dividends  to  its  stockliolders?  If 
not,  why  not? 

192.  What  four  factors  determine  the  amount  of 
profits?  What  industries  are  apt  to  have  the  most 
regular  profits?  Why  are  the  profits  of  railroad  equip- 
ment companies  so  variable? 

193.  Why  is  it  desirable  that  a  corjioration  should 
establish  and  maintain  from  year  to  year  a  regular 
dividend  rate?  How  may  regularity  of  dividends  be 
secured  in  spite  of  irregularity  of  profits? 

194.  Why  is  great  prudence  and  foresight  on  the 
parts  of  the  directors  in  declaring  dividends  essential  to 
the  best  interests  of  a  corporation  ? 

CHAPTER  XXII 


19.5.  What  arc  the  two  important  classes  of  better- 
ments? 

190.  What  arc  the  three  important  sources  of  funds 
for  betterments  f 

197.  What  are  the  advantages  of  providing  for  bet- 
terments !)y  appropriations  from  earnings? 


QUIZ  QUESTIONS 


583 


198.  What  are  the  two  objections  to  this  method? 
IN,  199.  What  three  motives  may  lead  stockholders  to 
oppose  a  policy  of  providing  for  betterments  by  appro- 
priations from  earnuigs?  How  do  corporation  offic  .rs 
sometimes  manage  to  follow  this  policy  without  the 
consent  of  even  a  majority  of  stockholders? 

200.  Review  briefly  from  memory  the  case  of  the 
Lehigh  Valley  Railroad  Company  and  show  how  Presi- 
dent Walters  for  some  years  pursued  the  policy  referred 
to  above. 

201.  Show  how  the  Union  Bag  and  Paper  Company 
is  now  profiting  by  reason  of  having  previously  pursued 
this  policy. 

202.  When  antl  how  may  funds  for  betterments 
safely  be  borrowed  ? 

203.  What  policy  as  to  provision  for  betterment  ex- 
(lenditures  is  followed  by  the  Pennsylvania  Railroad? 

204.  What  are  the  comparative  merits  of  bond  and 
of  stock  issues  as  means  of  raising  funds  for  better- 
ments? 


CHAPTER  XXIII 

205.  Define  "surplus." 

200.  Give  and  discuss  briefly  four  sources  of  surplus. 

207.  What  is  the  fifth  source  of  surplus?  Can  a 
surplus  be  bu'lt  up  to  any  considerable  amount  by  this 
inetluKl? 

208.  What  was  the  policy  of  most  of  the  industrial 
trusts  as  to  surplus  in  the  first  few  years  of  their  exist- 
ence f     What  were  the  results  of  their  policy? 

200.  How  may  a  surplus  be  invested?  What  general 
principle  should  be  followed? 


534 


CORPORATION  FINANCE 


210.  What  is  meant  by  using  the  surplus  as  a  "rainy 
day  fund"?  What  companies  follow  this  practice? 
What  is  the  argument  in  its  favor?  What  are  its  dis- 
advantages? 

211.  What  is  the  usual  practice  in  this  country  with 
reference  to  the  use  of  a  surplus? 


CHAPTER  XXIV 


212.  What  should  be  the  eflFect  on  dividends  of 
putting  a  surplus  back  into  the  property  of  a  corpora- 
tion? Is  the  effect  ever  to  increase  dividends  in  a  pro- 
portion greater  than  the  proportion  of  surplus  so  in- 
vested to  the  original  corporate  capital?    If  so,  when? 

213.  How  may  stock- watering  be  a  method  of  dis- 
tributing a  surplus  to  stockholders?  Give  an  illustra- 
tion. Why  is  it  that  a  stock  paying  a  regular  dividend 
of  4  per  cent  often  sells  for  more  than  half  as  much  as  a 
stock  paying  an  equally  regular  and  certain  dividend 
of  8  per  cent? 

214.  What  are  subscription  privileges?  How  may 
they  be  used  as  a  method  of  distributing  surplus? 

213.  How  does  a  subscription  privilege  give  an  op- 
portimity  for  cheap  investment?  What  four  methods 
may  be  used  by  stockholders  in  order  to  secure  quick 
cash  profits? 

216.  Wliat  is  the  methml  known  as  the  "subsequent 
sale"?     What  are  the  objections  to  its  use? 

217.  What  is  the  "short  selling"  method?  Wliat  is 
the  objection  to  its  use? 

218.  What  is  the  method  known  as  "sale  of  old 
stock"?    WTiy  cannot  it  always  be  used? 

219.  Wliat  is  the  method  known  as  "sale  of  rights"? 


QUIZ  QUESTIONS 


586 


What  is  meant  by  a  "right"  in  New  York?  What  does 
Wie  same  word  mean  in  Philadelphia?  What  is  the 
Objection  to  the  use  of  this  method? 

220.  What  factors  determine  the  theoretical  value  of 
a  right?  What  is  the  formula  commonly  used  on  the 
New  York  Stock  Exchange?  Why  is  the  market  value 
of  a  right  usually  less  than  its  theoretical  value? 

221.  is  the  granting  of  privileged  subscriptions  a 
methcKl  of  stock  watering?  Are  they  objectionable  on 
tha*  account? 


CHAPTER  XXV 

222.  What  good  reason  can  you  give  for  taking  up 
the  study  of  corporate  manipulation? 

228.  Is  it  true  that  the  corporate  form  favors 
manipulation?    If  so,  why? 

224.  Is  any  force  at  work  in  the  financial  and  in- 
dustrial world  which  has  a  strong  teiidcncy  to  check 
manipulation? 

225.  What  four  classes  or  bodies  of  persons  may 
endeavor  to  manipulate  a  corporation  for  their  own 

»>enefit? 

286.  How  may  high  salaries  be  used  as  a  method  of 

manipulation? 

227.  How  may  the  power  to  bind  a  corporation  by 
purchases  and  contracts  become  a  means  of  manipula- 
tion? Is  it  usually  iwssible  to  find  a  legal  remedy  or 
punisliment  f 

J2S.  How  may  the  power  to  form  new  companies  to 
handle  esptciiUy  profitable  business  l>e  used  as  a  method 
(»f  manipulation?  How  was  this  principle  applied  by 
Commodore  Vanderbilt? 


536 


CORPORATION  FIXANCK 


229.  How  may  a  corporate  officer  manipulate  a  cor- 
poration by  reason  of  having  "inside"  information. 

230.  Is  there  reason  to  think  that  the  use  of  these  hA 
methods  of  manipulation  is  not  uncommon? 

231.  Why  have  Canadian  companies  been  compara- 
tively free  from  manipulation? 


CHAPTER  XXVI 

232.  Wliy  do  not  directors  who  wish  to  manipulate  a 
corporation  m  their  own  interest  enrich  themselves  by 
voting  exorbitant  fees  to  themselves?  What  four 
methods  do  such  directors  commonly  use? 

233.  How  may  directors  misuse  their  power  to  make 
contracts  on  behalf  of  their  corporation?  Illustrate  by 
reference  to  the  case  of  the  Minnesota  railroad  company 
cited  in  the  text. 

234.  Why  do  not  the  courts  interfere  in  such  cases? 

235.  How  may  directors  manipulate  by  forming 
new  companies  or  transferring  credit  or  assets  of  their 
company  to  some  other  company  ?    Give  an  illustration. 

236.  State  a  few  methods  of  juggling  the  accounts 
of  corporations  wl.ich  are  not  infrequent.  How  may 
directors  profit  by  juggling  the  accounts  of  their  cor- 
poration ? 

237.  Wliat  is  meant  by  "window-dressing"?  How 
may  it  be  used  f)y  directors  as  a  method  of  manipula- 
tion ? 

238.  What  remedies  for  this  kind  of  manipulation 
may  be  suggested? 

239.  How  may  directors  secure  gain  for  themselves 
by  inflicting  loss  or  even  bankruptcy  on  their  corpora- 
tion?   Give  two  illustrations. 


QUIZ  QUESTIONS 


587 


240.  Review  the  essential  features  of  the  case  cited 
11^  the  text.  IIow  mi|?ht  the  manipulation  of  the  cor- 
\>t4ration  in  this  case  liave  heen  prevented? 

241.  What  faults  are  there  in  the  form  of  the  Annual 
Statements  in  Canada? 

242.  What  information  should  there  be  in  an  annual 
statement  of  a  corporation? 

243.  What  is  the  attitude  in  Canada  toward  quarterly 
reports?     Why? 


CHAPTER  XXVII 


244.  How  may  stockholders  fraudulently  secure 
profit  for  themselves  at  the  expense  of  the  creditors 
of  the  corporation? 

245.  What  are  the  essential  facts  in  the  well-known 
case  of  Chicago  and  Alton  Railroad  Company? 

246.  How  may  subsidiary  companies  lie  used  as  a 
means  of  manipulatitng  a  corporation  and  defrauding 
creditors  ?     Illustrate. 

247.  Review  the  main  facts  in  the  Central  of  Georgia 
Railway  case  cited  in  the  text. 

248.  Show  how  the  minority  stockholders  in  a  cor- 
poration may  be  "squeezed"  by  wilful  mismanagement 
on  the  part  of  the  majority  stockholders  and  illustrate 
by  reference  to  the  case  of  the  Olympic  Theatre  Com- 
pany cited  in  the  text. 

249.  Review  from  memory  the  series  of  transactions 
in  the  real  estate  proposition  cited  in  the  text  and  show 
exactly  how  the  minority  stockholders  in  the  I^ong  View 
Land  Company  were  defraiided. 

2.50.  Review  from  memory  the  series  of  operations 
carried  on  by  I^.  A.  Ehrenbahn  cited  in  the  text  and 


588 


CORPORATION  FINANCE 


show  how  they  all  worked  in  favor  of  the  manipulation 
of  his  deceased  brother's  estate  in  his  own  interest. 

251.  Mention  four  measures  preventive  of  manipuld** 
lion  that  should  be  taken  by  honest  stockholders. 


CHAPTER  XXVIII 


'true"   and   "legal"   in- 


252.  Distinguish    between 
solvencv. 

» 

258.  Mention  four  possible  causes  of  true  insolvency. 

254.  What  are  the  chief  causes,  according  to  Brad- 
street's  table,  of  legal  insolvency?  What  is  the  real 
meaning  of  the  phrase  "lack  of  captial"  when  used  in 
this  connection  ? 

255.  What  were  the  two  causes,  according  to  the  Wall 
Street  Journal,  of  the  failure  of  the  Detroit,  Toledo 
and  Ironton  Railway  Company  in  1909? 

250.  :Menti()n  three  immediate  causes  of  legal  in- 
solvency in  addition  to  "lack  of  capital." 

257.  What  is  bankruptcy?  Can  a  corporation  be- 
come a  voluntary  bankrupt  ?  Can  all  corporations  be- 
come involuntary  bankrupts ?  Is  dissolution  of  the  cor- 
poration a  common  mctluMl  of  handling  insolvency?  If 
not,  why  not? 

258.  What  is  a  "bill  in  chancery"?  By  whom  may 
it  be  presented?  How  may  a  friendly  receiver  for  a 
corporatirm  l)e  obtained?  \Vhat  courts  have  jurisdic- 
tion in  case's  of  corporate  insolvency  and  receiverships? 

259.  What,  briefly  stated,  are  the  duties  of  the  re- 
ceiver of  a  faiiffl  corporation? 

260.  From  what  source  does  he  obtain  his  authority? 
How  are  his  powers  limited?  May  he  incur  debts  bind- 
ing on  the  insolvent  corporation  ?   Does  he  receive  a  fee? 


QUIZ  QUESTIONS 


589 


261.  What  is  the  principal  cause  of  failures  in  Can- 
ada? Are  there  many  corporation  failures  in  Canada? 
Vh»at  percentage  of  failures  are  charged  to  individuals? 


I 


CHAPTER  XXIX 

262.  Why  is  it  usually  necessary  and  desirable  to  re- 
organize large  insolvent  corporations  rather  than  to  sell 
their  property  and  distribute  the  assets  among  the 

creditors? 

263.  Why  is  the  formation  of  committees  usually  the 
first  step  in  reorganization?  How  are  these  committees 
appointed?  How  much  authority  do  they  possess? 
How    may    a   general    reorganization   committee    be 

formed? 

264.  Why  are  bondholders  usually  ready  to  agree  to 
a  reorganization  rather  than  foreclose  and  force  a  sale 
and  distribution  of  assets? 

265.  What  are  the  main  problems  and  difficulties  that 
confront  a  general  reorganization  committee?  How 
are  the  relative  standing  and  value  of  the  various  issues 
of  mortgage  bonds  and  other  claims  on  the  corporation 
determined?  What  concession  is  usually  made  to  the 
stockholders  of  the  corporation? 

266.  Name  the  four  main  objects  of  every  reorgani- 
zation. Why  is  it  necessary'  usually  to  raise  considerable 
amounts  of  cash  ? 

267.  What  are  the  three  possible  methods  of  raising 
cash?  Why  do  almost  all  reorganizations  of  insolvent 
corporations  involve  assessments  on  security  holders? 
How  large  may  the  assessments  on  stockholders  be 
I  >  lade  ?  Under  what  circumstances  may  bondholders  be 
induced  to  pay  assessments? 


540 


CORPORATION  FINANCE 


268.  What  three  classes  of  fixed  charges  are  usually 
reduced  in  reorgahization  if  What  threat  may  be  us^d 
to  force  an  acceptance  of  a  reasonable  reduction  ?  WH»«t 
principle  is  usually  followed  in  determining  the  maxi- 
mum total  amount  of  fixed  charges  to  be  imposed  upon 
the  reorganized  company  ? 

269.  How  are  bondholders  usually  compensated  for 
the  reduction  in  their  yearly  interest?  What  is  the 
effect  on  the  total  capitalization  of  the  company  ?  What 
factors  determine  whether  or  not  the  reorganized  com- 
pany shall  operate  under  the  charter  of  the  old  com- 
pany? Why  is  a  voting  trust  frequently  formed  at  the 
time  of  organization? 

270.  Summarize  briefly  from  memory  the  principles 
of  reorganization  laid  down  in  this  chapter. 


CHAPTER  XXX 


271.  Sketch  from  memory  the  growth  of  the  Santa 
Fe  System.  What  were  the  effects  on  the  comp«ny's 
financial  strength  of  the  rapid  expansion  in  the  years 
1884-1888? 

272.  What  were  the  main  results  of  the  reorganiza- 
tion of  1889  ?  What  were  some  of  the  events  that  led  up 
to  the  failure  of  the  company  in  1893? 

278.  What  was  the  substance  of  the  so-called  English 
plan  of  reorganization?  Why  was  it  not  adopted? 
What  were  the  main  features  of  the  plan  that  was  finally 
adopted?  What  have  been  the  results  of  this  reor- 
ganization? 

274.  Sketch  from  memory  the  growth  of  the  Rock 
Island  System. 

275.  Outline  the  plan  of  reorganization  brought  for- 


QUIZ  QUESTIONS 


54L 


ward  in  1902.  What  was  the  prime  object  of  this  re- 
o'^anization?  Was  that  object  attained?  Show  how 
civNitrol  of  the  Rock  Island  System  may  have  been  se- 
cured by  the  Moore  crowd  without  any  permanent  out- 

276.  Why  did  the  Westinghouse  Company  fail? 
What  was  the  main  problem  that  confronted  the  reor- 
ganization committees?  What  were  the  main  features 
of  the  plan  adopted?  . 

277.  How  may  the  necessity  for  future  reorganization 
be  guarded  against  when  forming  the  consolidation? 

278.  Describe  the  reorganization  of  the  Dommion 

Sawmills,  Limited. 

279.  Describe  the  financing  of  the  absorption  of  the 
Lake  Superior  Paper  Co.,  Limited,  by  the  Spanish 
River  Pulp  and  Paper  Mills,  Limited. 

280.  Wliat  further  information  is  given  in  the  letters 
issued  by  the  executives  of  this  company? 

281  What  problems  are  raised  by  the  reorganization 
.)f  the  Canadian  Coal  and  Coke  Co.?  What  were  the 
terms  of  its  reorganization? 

282.  What  was  the  principal  objection  to  the  plan? 

288.  In  view  of  Mr.  Cahan's  letter  do  you  think  the 
objection  is  justified? 


INDEX 


Accountant's  work  in  consolidation, 

313-313. 
Adaptability     of     corporate     form, 

5-8. 

Addicks,  J.  Ed.,  19. 

"Allen"    corporations,    51. 

A.  Macdonald  Company,  Limited, 
Prospectus  of,  382-283. 

Allum,  T.  C,  on  annual  statements, 
433-433. 

Amalgamated  Asbestos  Corpora- 
tion, 234-235. 

American  Bridge  Company,  243, 
250. 

American  Ice  Co.,  453-454. 

American  Kitchen  Products  Co.  of 
Canada,    Limited,    charter    of, 

70-72. 
American   Law    Review,   403. 
American    Locomotive  Co.,    137. 
American  Sheet  Steel  Co..  243,  248, 

255. 
American  Steel  and  Wire  Co.,  240, 

243,  344,  246.  347,  255. 
American  Steel  Hoop  Co.,  343,  348, 

355. 
American  Telephone  and  Telegraph 

Co. 
Number  of  stockholders,  7. 
Watered  stock,  390. 
American   Tin   Plate  Co.,  243,  348, 

255. 
American  Thread  Co.,  M2,  115.  12«i. 
Annual  statements  in  Canada. 
Form  of,  431-W3. 
What  should  be  Included  In,  432- 

433. 
Appointment    of    receiver,    459-460 
Argentine  Republic  bonds,  23. 


Ariuona,  corporate  laws  of,  54,  57, 
5H. 
Atchison,  Topeka  and  Santa  F€  R. 

U.  Co.,  350.  4«7. 
First  reorgani«atlon,  487-489. 
Growth.  484-t8«. 
Second  reorgnniiatlon,  489-493. 
Atlantic  and  Pacific  R.  R.  Co.,  485. 
Atwood,  Albert  W.,  336. 

B 

Bad  management,  453. 

Balance  sheets,  96-97. 

Baldwin    Locomotive  Works,  365. 

Baltimore  and  Ohio  R.  R.  Co.,  157. 

Bank  of  Augusta  vs.   Earle,  49-51. 

Bank  loans.  128-129. 

Bankruptcy     and    Insolvency,     457- 

459. 
Psnks    and    corporations 

ada,  118-134. 
Banks,  function  of,  107. 
"Bare  majority,"  510-513. 
Bay  State  (Has  Co.    19. 
Bethlehem    Steel    Corporation,    113, 

115,  137,  135. 
Betterment  exi)enses,  363,  376. 
Borrowing  funds  for,  373-374. 
Classes  of,  3(i3-364. 
Conclusions  as  to,  375-376. 
I.ehigh  Valley  R.  R.  policy.  3«8- 
372. 
Pinnsylvania     R.     R.     policy,    374- 

37,5. 
.Sources  of  funds  for,  3(>4-365. 
.Stockhold.rs'        attitude        toward, 

366-368. 
I'nion   Bag   and    l'a|.cr  Co.   policy, 

372-373. 
Bill  in  Chancery,  459. 


in    Can- 


548 


MICROCOPY   RESOIUTION   TEST   CHART 

(ANSI  and  ISO  TEST  CHART  No    7, 


1.0 


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as  (716)    J88  -  5989  -  Fa< 


544< 


INDEX 


Black    Lake   Consolidated   Asbestos 

Co.,  235. 
Blackstone,  2,    4. 
Bondholders'  niiijority,  509-513. 
Bonds,  see  "Corporate  Bonds." 
Booth,  A.  &  Co.,  113,  115,  127. 
Boston  and  Afaine  R.  11.  Co.,  173- 

174. 
Bucket  shops,  300-302. 
Business    failures    in    Canada,    4G4- 

465. 
By-laws,  28-36. 


Cahan,  C.  H. 

On  "bare  majority,"  511-512. 
California,  corporate  laws  of,  57. 
Canada  Bolt  and  Nut  Co.,  232. 
Canada  Cement  Co.,  largest  consol- 
idation, 229. 
Canadian  Coal  and  Coke  Co.,  507- 

509. 
Canada  Transportation  Lines,  Lim- 
ited, 236-238. 
Canadian  Pacific  Lumber  Co.,  Lim- 
ited, 232. 
Capital,  lack  of,  453-454. 
Capitalization, 

Factors  affecting,   116-118. 
In  reorganization,  480-482. 
Of  V.  S.  Steel  Corporation,  255. 
Carnegie,  Andrew,  239,  244. 
Carnegie  Steel  Co.,  106,  241,  243. 
214.  246,  £49,  256,  352,  353,  365, 
388. 
Central  of  Gergia  R.  R.  Co.,  439- 

441. 
Centralization    of    cori)orate    man- 
agement, 9-10. 
Charter. 

Essential  features  of,  20-22. 
Important  feature  of,  28. 
M'here  to  obtain,  52. 
Oiicago  and  Alton  R.  R.  Co.,  436- 

438. 
Chicago,   Burlington  &   Quincy    R. 
R.  Co.,  I6'3. 


Chicago,  Rock  Island  &  Pacific 

R.  Co.,  389,  493,  495,  496,  4 

Chicago,  Rr.  s  Island  &  Pacific  F 

way  Co.,  389,  493,  495,  497, 

Choctaw,  Oklahoma  and  Gulf  R 

495. 
Classification   of  corporations, 
Close,  94. 

Holding  companies,  95-101. 
Large,  94. 
Non-stock,  93. 
Open,  94. 

Parent  companies,  94-95. 
Small,  94. 
Stock,  93. 
Colorado  Mildland  R.  R.  488. 
Commission      on      I'niform      S 

Laws,  73-74. 
Common  law  of  corporations,  1' 
Companies'    Act    of    the    Domii 
65-70. 
On  directors'  powers,  67-68. 
On  official  statements,  68-69. 
On  shareholders'  liability,  66-( 
Connecticut,    corporation    laws 

57-59. 
Consolidation, 

Advantages  of,  229-230. 

Basis  of,  230-232. 

Canada's    experience    In    fom 

228-230. 
Reorganization  of  industrial 
solidations,  334-236. 

Contracts, 

Manipulation    by    directors, 
418. 

Manipulation  by  officers,  405-1 
Conwnjr,  Jr.,  Dr.  Thomas,  192. 
Conyngton,  Thomas,  22,  29,  53. 
Corporate  bonds. 

Collateral  trust,  161-163. 

Convertible.  181-183. 

Debenture,  171-171. 

Equipment  trust,  163-168. 

Gold,  180. 

Income,  174-177. 

Joint,  175,  179. 


"^ 


INDEX 


646 


fe  Pacific  R. 
5,  496,  497. 
Pacific  Rajlr- 
'95,  497,  4(|8. 
Gulf  R.  K. 


'ations, 
15-101. 

-95. 


t.  488. 
form      State 

itions,  17-18. 
e    Dominion, 

67-68. 
68-69. 
hty,  66-67. 
m    laws    of. 


)0. 

in    forming, 
dustrial  con- 

• 

rectors,    415- 

ers,  404-407. 
IBS,  193. 
29,  53. 

163. 
)-168. 


Corporate  bonds — (Continued). 
Names  of,  158. 

Manner  of  payment  of,  156,  179. 
/Mortgage,  149-150, 157. 
Participating,  175. 
Payment  of,  179,  181. 
Profit  sharing,  175. 
Purposes  of,  156,  179-181. 
Receivers'  certificates,  179. 
Redeemable,  181. 
Redemption  of,  156,  171-181. 
Registered,  181. 
Security  of,  155-156. 
Sinking  fund,  158-161. 
Serial,  181. 
Corporate  entity,  3. 
Corporate  form,  abuse  of,  409. 
Corporate  funds. 
Borrowing,  110-116. 
Security  issues,  116-118. 
Sources  of,  105-110. 
Corporate  mortgage. 
Closed,  153-154. 

Deed  of  trust  133-1S5,  150-153. 
Limited  open-end,  153-154. 
Open-end,  153-154. 
Trustee  under,  436. 
Corporate  name,  94. 
Corporate  purposes,  34-S8. 
Corporate  organiiation,  53. 
EAciency  of,  47-48. 
Flexibility  of,  64. 
"Corporation  Finance,**  111. 
Corporation  laws, 
Canadian,  65-79. 
Comparative  summary,  58-69. 
Liberality  of,  55-56. 
Permanence  of,  56-57. 
Reputation  of,  57-58. 
Corporations  in  ancient  nations,  4. 
Corporations, 
Definitions  of,  9. 
Right  to  do  business  ir>   foreign 

states,  49-51. 
Statements  to  banks,  198-199. 
Cunard  Co.,  389. 
Curb  market,  994-995. 
C-VI-85 


Daggett,  Stuart,  484-485. 
Dartmouth  College  case,  9. 
Deed  of  trust,  151. 
Delaware,  corporate  laws  of,  53,  54, 

56,  57,  59. 
Detroit,  Toledo  and   Ironton   Rail- 
way Co.,  454-456. 
D<»ductions  from  income,  355. 
Defining    and    controlling    instru- 
ments, 17. 
Depreciation  reserves,  351-354. 
Dill,  James  B.,  95. 
Directors, 
"Dummy,"  44-45. 
Liabilities  of,  45-47. 
Manipulation  by,  414-431. 
District    of    Colimibia,    corporation 

laws  of,  54,  57,  59,  60. 
Dissolution,  459. 
Disadvantages    of   corporate    form, 

13-16. 
Dividends, 
Cumulative,  80. 
Fluctuations  in,  560. 
Non-cumulative,  80. 
Paying,  355-356,  361-369. 
Reductions  in,  366. 
Regularity  of,  360-361. 
"Domestic"  corporations,  51. 
Dominion  Steel  and  Coal  Corpora- 
tion, Limited, 
History  of,  86-99. 
"Dumnqr**  directors,  44-45. 


E 


Eastman  Kodak  Co.,  971. 
Eflciency  of  corporate  organisation, 

47-48. 
Electric  railroads,  359. 
Equipment  companies,  356. 
Equipment  trust  bonds,  165. 
Erie  Railroad  Co.,  137. 
Essential  features  of  bj^wa,  8S- 


d46 


INDEX 


Essential  features  of  charter,  20-22. 
Expenses  of  incorporation,  13-14. 
Extra-provincial,  licensing  acts,  69- 
70. 


Federal  Act   (See  Companies'  Act 

of  the  Dominion),  65. 
Federal    Steel    Ck).,    240,    243,   244, 

246,  347,  255. 
Fixed  assets,  377. 

Value  of,  147-149. 
Foreign  corporations,  51. 
Fraud,  452-453. 
Frick,  H.  C,  Coke  Co.,  341. 


G 

Gates,  John  W*.,  255. 
General  Electric  Co.,  343-344. 
Government  control  of  corporations, 

15-16. 
Greene,  Thomas  L.,  111. 
Gross  earnings, 

Determination  of,  349-350. 

Statement  of,  350. 
Gulf,  Colorado  &  Santa  F€  R.  R., 
485. 

H 

Hall,  Henrjr,  182. 
Harriman,  E.  H.,  367. 
Hamburg-American  Line,  3<U. 
Herring-Hall-Marvin  Safe  Co.,  111- 

112,  126. 
Hyde,  James  H.,  318. 


Illinois  Central  R.  R.  Co.,  302,  398. 
Illinois,  Corporation  laws  of,  57. 
Important  feature  of  charter,  28. 
Incorporation, 

Agreements  prior  to,  63-64. 

Expenses  of,  53-55. 


Where  to  incorporate,  52-53. 

Wide  range  of  choice  in,  64. 
Income,  354-355. 
Income  bonds,  174-177. 
Influence  of  corporation,  16. 
Individuals    interested    in    corpon 

tion,  37. 
Inheritance  of  surplus,  378. 
Inside  information,  410-413. 
Ins(»lvency, 

Causes  of  legal,  453-454,  456-457. 

Causes  of  true,  451-453. 

Detroit,   Toledo  &    Ironton,   45 
456. 

'  lethods  of  handling,  457-460. 
Installment  method  of  getting  cas 

336-339. 
Integration,  242. 
Interborough-Metropolitan  Co.,  10 

101,  305. 
International  Harvester  Co.,  343. 
Interstate    Commerce    Commissio 

353,  425,  436. 
Inventions,  352. 
Investment, 

Amount  in  fixed  capital,  340-34 

Amount  in  working  capital,  34 
343,  345-346. 

Definition  of,  108-109. 

Importance  of,  336. 

Of  surplus,  382,  392. 

Practice    of    large    corporatioi 
343-345. 


Jones  and  Laughlin  Steel  Co.,  946. 
Jones,    H.    V.    P.,    on    short-tei 

loans,  140. 
Journal    of    Accountancy,    74,  12 

213. 

L 

Lack  of  capital,  453-454. 
Land  notes,  three-year,   143-144. 
Lawson,  Thomas  W.,  90. 
Leeds,  Wm.  B.,  494. 


INDEX 


547 


Lehigh  Valley  R.  R.  Co.,  368-373, 

396. 
Liabilities, 

I  Of  directors,  45-47. 
Of  stockholders,  42-44. 
Of      stockholders      of      National 
Banks,  12. 
Limited  credit  of  corporaUons,  14- 

15. 
Limited  liability  of  corporations,  11- 

13. 
Limited  powers  of  corporations,  14. 
LitUe,  Stephen,  350,  489. 

M 

MacKenxie,  Sir  WUliam, 
Report       concerning       Canadian 
Northern  Railway  Co.,  142-143. 
Maine,  corporation  laws  of,  63,  54, 

56,  57,  60. 
Manipulation  by  directors. 
Accountant's    statement,    433-494. 
Attitude  of  courts,  418-419. 
Contracts,  415-418. 
Juggling  accounts,  420-423. 
Loss   of   control   dangerous,  488- 

431. 
Loss  to  corporation,  426-428. 
Methods  of,  415. 
New  companies,  41^420. 
Remedies,  424-426. 
Manipulation  by  officers. 
Contracts,  405-407. 
Corporate  form  favors,  401-409. 
Methods  of,  404. 
Misuse     of     inside     information, 

410-412. 
Necessary  evil,  409-403. 
New  companies,  407-410. 
Ought  we  to  study,  401. 
Remedy,  403. 
Salaries,  404-405. 
Manipuation  by  and  for  stockhold- 
ers. 
Central  of  Georgia  R.  R.  Income 
account,  439-441. 


Chicago  and  Alton  deal,  436-438. 

Creditors,  causing  loss  to,  435-436. 

Ocean  Steamship  Co.,  440. 

Remedies,  448-449. 

Squeesing    minority    stockholders, 

441-44.^ 
Subsidiary    companies,    438-439. 
i.iarshall.  Chief  Justice,  2. 
Massachusetts,  Ciirporation  laws  of, 

57,  60-61. 
McPherson,  F.  H.,  213. 
Meade,  Edward  S.,  98,  160,  242,  370, 

381. 
Meetings  of  stockholders,  34. 
Merger  (see  Consolidation). 

Method  of  creating  corporation,  19- 
20. 

Method    of    getting    cash,    339-340. 

Midvale  Steel  Co.,  41. 

Minnesota,  corporation  laws  of,  57. 

Moore  Companies,  243,  246'. 

"Moore  Crowd,"  494,  495,  496,  497. 

Morgan,  J.  P.,  945. 

Morgan,  J.  P.  &  Co.,  391,  399. 

Mortgage  bond,  nature  of,  14»-15a 


National   Steel   Co,  941,  948,  M4, 

947,  955. 
NaHonal   Tube   Cc  »*1.  «*3.  »♦*• 

246,  247. 
Nevada,  corporatloB  Uw»  of,  61. 
New  Jersey, 
Corporation  laws  of,  43,  54,  5«, 

57,  61-62,  98-99. 
Incorporation  of  U.  &  Sted  Cor- 
poration, 246. 
New  Jersey  Court  decision,  96-97. 
New  York,  corporation  laws  of,  53, 

54,  56,  57,  58,  69. 
New  York  Central  R.  R.  COh  SM, 

409. 
New  York  Curb  Market,  396. 
New  York  Evening  Post,  81S-314. 


548 


INDEX 


New  York,  New  Haven  &  Hartford 

R.  R.  Co.,  174. 
New  York  Stock  Exchange,  398. 
"Non-stock"  corporations,  1. 
Northern      Paciflc-Great    Northern 

162,  179. 


Obligations,  quick,  457. 
Ocean  Steamship  Co.,  440. 
Officers  of  Corporation,  34-35. 
Oliver  Mining  Co.,  241. 
Operating  expenses,  350-351. 
Oregon  Short  Line,  175,  467. 
Overcapitalisation, 

Dangers  of,  232,  234. 
Over-estimation  of  assets,  451. 
Ownership  of  stock,  33-34. 


Pennsylvania, 

Corporation  laws  of,  57. 

Cumulative  voting  required,  ia-I9, 
77. 
Pennsylvania  R.  R.  Co.,  312-313. 

Annual  report  of,  374-375. 

Number  of  stockholders,  7. 

Policy  of,  374. 
Perkins,  George  W.,  318. 
Permanence  of  corporations,  8-9. 
Personality  of  corporations,  3-4,  8, 

17. 
Petition  for  receiver,  459. 
Philadelphia  Stock  Exchange,  991. 
Pittsburg,  Bessemer  and  Lake  Erie 

R.  R.,  841. 
Pittsburg  Steamship  Co,  84L 
Pooling,  97. 

Popularity  of  corporate  form,  5. 
Post,  William,  130. 
Powers  of  directors,  45-47. 
Prices  of  raw  materials,  357. 
Production    percentages    of  indus- 
trial companies,  357-358. 


Profits,  variability  of,  356-360. 
Promoters, 
Bankers  as,  199. 

Contracts  by,  205.  4 

Definition,  184. 
Difficulties  of,  211-212. 
Engineering   firms   as,   199-201. 
Function  of,  184-186. 
Lawyers  as,  199. 
Misleading    statements    by,    204- 

205. 
Pay  of,  205-206',  208-209. 
Professional,  197-199. 
Risks  and  labors  of,  208,  209. 
Secret  profits  of,  201-209. 
Promotion, 
Assembling    a    proposition,    187- 

188. 
Basis    of    consolidation,    913-220, 

225-226. 
Discoveiy  of  a  proposition,  186- 

187. 
Discovery  of  small  consolidation, 

212-213. 
Distribution  of  stock,  191. 
Financing  a  proposition,  188-189. 
Illustration   from  Electric  R.   R. 

Co.,  192-196. 
Methods  of  raising  cash,  991-923. 
Necessity  for  cash,  920-221. 
Of  industrial   combinations,  910- 

211. 
Of  Interborough  -  Metropolitan 

consolidation,  226-228. 
Providing  funds,  190-191. 
Sale  of  stock,  191-192. 
Prospectus, 
Characteristics   of,  264-960. 
Ideal,  970-971. 
Investment,  968-970. 
Of  Canadian  corporation  securi- 
ties market,  980-983. 
Speculative,  966-968. 
Proxy,  38-40. 

Purposes  of  U.  S.  Steel  CorponiF 
tion,  95. 


INDEX 


549 


Q 

^arterly  statements,  433-484. 
Quick  Obligations,  457. 


Rock  Island  System, 

Growth,  493-495. 

Reorganisation,  495-498. 
Roosevelt,  Theodore,  57. 

S 


Railroad  reorganisation,  484. 
Railroads  reorganised  in  1907,  483. 
Railwajr  loans  in  Canada,  141. 
Receivers'  certificates,  178,  179. 
Receiver, 
Duties  of,  460-469. 
Powers  of,  469-46S. 
Regulation    of    "foreign"    corpora- 
tions, 51. 
Reid,  Daniel  G.,  955,  494. 
Relation    between    Canadian   banks 

and  corporations,  118-194. 
Reorganisation, 

Assessments  for  cash,  474-477. 
•Atchison,  TopAa  ft  Santa  Fe  R. 
R.  Co.,  483-499. 
Capitalisation  in,  480-489. 
Cash  requirements,  474-475. 
Committees,  468-470. 
Fixed  charges  reduced,  478-480. 
Foreclosure,  470-471. 
Intricate  financing  of  «,  504-510. 
Problems  of,  471-474. 
Reasons  for,  460-468. 
Rock  Island  Co.,  405-498. 
Summary,  489. 
Two  Canadian  examples  of,  509- 

504. 
Westinghouse  Co.,  498-501. 
Report   of    Industrial    Commission, 

905-907. 
Revaluation  of  fixed  assets,  S79. 
"Right,"    898,    394,    395,    396,    397- 

399. 
Rights  of  creditors,  44. 
RighU  of  stockholders,  87-38. 
Rock  Island  Co..  489-440,  495-496, 
497,  499. 


St  Louis  ft  San  Francisco  R.  R. 

Co.,  467,  485,  488,  491,  498. 
Salaries,   manipulation   of,  by   offl- 

cers,  404-405. 
Sale  of  old  stock,  397. 
Sale  of  rights,  395-397. 
Sample  by-laws,  99-33. 
Sample  charter,  99-94. 
Saving  from  income,  379-880. 
Schwab,  Charles  M..  956,  957. 
Securities, 
Banking  house  methods  of  sdling, 

971-979. 
Buying  on  margin,  998-999. 
LisUng,  999-994. 
Methods  of  selling.  963-964,  975- 

978. 
Requirementa  of  banking  houses, 

979-973. 
Selling  short,  999-300. 
Selling  above  par  to  obtain  sur- 
plus, 378. 
Securities,  Canadian, 
Markets  for  corporation,  979-980. 
Prospectus  of  and  British  Inves- 
tor, 980-983. 
United   States  market  for,  983- 
984. 
Short  selling.  394-395. 
Short-term   loans   In   Canada,   138- 

148. 
South  Dakota,  corporation  laws  of, 

53,  54,  57. 
Smithers,  A.  W.,  on  five-year  equip- 
ment   notes    Issued    by    Grand 
Trunk  Railway  of  Canada,  169. 
.Southern  Kansas  R.  R.  Co.,  485. 
Southern  Pacific  R.  R.  Co.,  484. 
Spanish    River    Pulp    and    Paper 
Mills,  Limited,  504-507. 


550 


INDEX 


Speculation, 
Definition  of,  110-111. 
Importance  of,  387-388. 
Speyer  &  Co.,  317. 
Standard  Oil  Co.,  343. 
Lack    of    publicity    of    accounts, 

42. 
Organication  of,  101-106. 
Surplus  of,  380-381. 
State  constitution,  18-19. 
Stimulation  of  speculative  interest, 

303,  305. 
Stock, 

Buying,  393-393. 
Certificates  of,  65-68. 
Common,  79. 

Form  of  certificate  of,  78. 
Nature  of,  33-34. 
Par  vs.  market  value  of,  76-79. 
Preferred,  "cumulative,"  80. 
Preferred,  nature  of,  79-81. 
Preferred,  "non-cumulative,"  80. 
Preferred,  uses  of,  81-83. 
Watering,  349,  399,  401. 
Stock  corporations,  2. 
Stock  Exchange,  391-393. 
Methods  of,  395-297. 
Volume  of  business,  397. 
Stockholders, 
Attitude  towards  betterment  ex- 
penses, 366-368. 
Liability  of,  42-44. 
Meetings  of,  34. 
Surplus  belongs  to,  385-386. 
Stock  market  manipulation,  306-307. 
Stock  market,  303. 
Subscription  contract,  63. 
Subscription  privilege,  391. 
Surplus, 

Advantages  of  cash,  383-384. 
Canard  Co.  policy,  384. 
Definition  of,  377-378. 
Disadvantages  of  keeping  in  cash, 

384-385. 
Distribution  of,  436-437. 
Distribution  through  stock-water- 
ing, 389-391. 


4 


Distribution   through  subscription 

privileges,  391-392. 
Sale  of  old  stock,  395. 
Sale  of  rights,  395-396. 
"Short  selling,"  394-395. 
Subsequent  sale,  393-394. 
Effect  on  assets,  387-389. 
Effect  on  dividends,  387-389. 
Fixed  assets  as  a  form  of,  379. 
Functions  of,  383. 
Hamburg-American     Co.     policy, 

384. 
Investment  of,  383. 
Obtained  by  inheritance,  378. 
Policy  of  trusts,  381-383. 
Rainy  day  fund  theory,  382-385. 
Revaluation  of  assets  as  a  source 

of,  379. 
Saving  from  income  as  a  source 

of,  379-381. 
Sources  of,  378-381. 
Uses  of,  385-386. 
Syndicate  operations,  305-309. 


Taney,  Chief  Justice,  50. 

Taylor,  Sir  Frederidc,  on  Canadian 
credit,  280-381. 

Taxes,  354-355. 

Thompson,  Sejnmour  D.,  403. 

Transfer  of  stock,  34. 

Transferability  of  corporate  owner- 
ship, 10-11. 

"Trust  Finance,"  98,  160,  342,  381. 

Trusts,  97. 

Surplus  of,  381-383. 

Tuplin  Silver  Black   Fox  Corpora^ 
tion.  Limited,  384-390. 


U 


Underwriting, 
Advantages  to  buyers,  310-311. 
Advantages   to   corporation,   SOS- 
SI  1. 


INDEX 


551 


Underwriting.    {Conlinued.) 
Origin  of,  309-309. 
,     kWhen  advisable,  311-314. 
Underwriting  houses,  319-320. 
Underwriting   syndicates, 
Characteristics  of,  329-330. 
Distributing     securities     through, 

317-319. 
Example    of    speculative    dealing 

by,  332-334. 
Formal  agreement  of,  321-329. 
Functions  of,  330. 
Handling  speculative  issues,  331- 

332. 
Informal  agreements  of,  321. 
Pool  sale  through,  317. 
Types  of,  315-316. 
Why  formed,  314-315. 
Union  Bag  &  Paper  Co.,  372-373. 
Union  aPciftc  R.   R.  Co.,  40,  157, 

181,  467. 
U.  S.  Leather  Co.,  114,  115,  127. 
U.  S.  Steel  Corporation,  436,  343, 
389,  494. 
Additional  companies,  251-252. 
Basis  of  capitalisation,  255-258. 
Capitalization   at  beginning,  249- 

251. 
Conditions  before  formation,  241- 

245. 
Cost  of  charter,  54. 
Earlier  steel  consolidations,  240- 

241. 
Financial  changes  in,  353-255. 
Formation  of,  224. 
Method  of  promotion,  246-249. 
Number  of  stockholders,  7. 
Operating  policy,  258-359. 
Profits  of  promoters,  249. 
Prospectus  of,  346-349. 


Record  of  earnings,  257, 
Securities  of,  259-262. 
Standing  conunittees  of,  46. 
Syndicate  agreement,  322-329. 


Value  of  assets,  451-452. 
Vanderbilt,  Commodore,  409. 
Volume  of  sales,  357. 
Voting,  cumulative,  83-85. 
Voting  trusts,  77-78,  85-86. 

W 

Wabash  R.  R.  Co.,  173. 
Wages,  357. 
Walker,  Sir  Edmund, 
On  advancing  money  on  securities 
of  new  enterprises  pending  the 
sale  of  the  bonds,  119. 
On  banking  in  Canada,  123-134. 
On  short-term  notes,  144. 
WaU  Street,  395. 

Wall  Street  Journal,  319,  343,  453. 
Wall     Street     speculators,     classes, 

302-303. 
Wells  Fargo  Express  Co.,  367-368. 
Westinghouse  Electric  &  Manufac- 
turing Co.,  498-501. 
Western  Union  Tel.  Co.,  157. 
West  Virginia,  corporation  laws  of, 

54,57. 
Woodlock,  Thomas  P.,  355. 
Working  capital,  456-457. 
Forms  of,  341-343. 
Importance  of,  33«^S48. 
Practice   of   Pennsylvania   R.    R. 
Co.,  346-347. 


